FORECASTING
Forecasting
• Forecasting are estimated occurrence, timing or
magnitude of future events . Forecasting is a
subjective estimates of the future.
• Forecasts affect decisions and activities throughout an
organization
– Accounting, finance department
– Human resources department
– Marketing department
– MIS department
– Operations department
– Product / service design department
Forecasting in operations
• Manager should know the customer demand
of product and services to plan long and short
range estimates of each product/services and
overall demand to plan operations activities.
• Detail forecasting for individual items are used
for planning.
• Product demand forecasts are used to plan for
capacity, location and layout over a much
longer time span.
Forecasting as a planning tool
• In majority of the situations certainty of
happening a event is not there
• Assumptions are carried out during such
situations
• E.g.: adding a new product line in a
manufacturing unit
• Forecasting addresses these issues and provide
the manager with a set of tools and techniques
for the estimation process
• Forecast are the estimates of timing and
magnitude of the occurrence of future events
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Key functions of forecasting
• A tool for predicting events related to operations
planning and control
• An estimation tool
• A way of addressing the complex and uncertain
environment surrounding business decision
making
• A vital perspective for the planning process in
organizations
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Need of forecasting
• Majority of activities depends on future sales.
• Demand forecasting-decision on 3 M’s –men, material,
machinery.
• It is always necessary in the changing necessary and
uncertain technical, economical and market scenario.
• It throws light on the future trend of the market
• Needed for material planning in order to make
material available in right quantities and at the right
time for production.
• It is needed for schedule production activities in order
to ensure maximum utilization of plants capacity
Sources of data
• Source can be direct (primary)or indirect (secondary).
• Published documents by government and professional
bodies
• News papers, books and magazines
• Historical data
• Expert opinion
• Delphi technique
• Surveys or opinion polls
• Market research
• Trial marketing, Point of sales data systems
• Forecast from supply chain partners
Forecasting time horizon
• Time horizon:
• Short term forecasting
• Long term forecasting
• Medium term forecasting
Forecasting Across the Organization
• Forecasting is critical to management of all
organizational functional areas
– Marketing relies on forecasting to predict demand and
future sales
– Finance forecasts stock prices, financial performance,
capital investment needs..
– Information systems provides ability to share databases
and information
– Human resources forecasts future hiring requirements
TYPES OF FORECASTING MODELS
• Qualitative methods – Judgmental methods
Forecasts generated subjectively by the forecaster
Educated guesses
Non quantitative forecasting technique based upon expert
opinions and intuition . Typically uses when there are no
data available.
• Quantitative methods:
Forecasts generated through mathematical modeling
Qualitative Methods
Quantitative Methods
• Time Series Models:
– Assumes information needed to generate a forecast is
contained in a time series of data
– Assumes the future will follow same patterns as the past
• Causal Models or Associative Models
– Explores cause-and-effect relationships
– Uses leading indicators to predict the future
– Trend projection and liner regression analysis.
Time series analysis
• Forecasting models try to predict the future based on past data.
• Forecaster looks for data patterns as
Data = Historic pattern + Random variation
• Historic pattern to be forecasted:
– Level (long-term average) – data fluctuates around a constant mean
– Trend – data exhibits an increasing or decreasing pattern
– Seasonality – any pattern that regularly repeats itself and is of a constant
length
– Cycle – patterns created by economic fluctuations
• Random Variation cannot be predicted
Time Series Models
• Naive:
– The forecast is equal to the actual value observed during the
last period – good for level patterns
• Simple Mean:
– The average of all available data - good for level patterns
• Moving Average:
– The average value over a set time period
(e.g.: the last four weeks)
– Each new forecast drops the oldest data point & adds a new
observation
– More responsive to a trend but still lags behind actual data
© Wiley 2007
Moving Average
Time Series Models (continued)
• Weighted Moving Average:
• All weights must add to 100% or 1.00
e.g. Wt .5, Wt-1 .3, Wt-2 .2 (weights add to 1.0)
• Allows emphasizing one period over others; above
indicates more weight on recent data (Wt=.5)
• Differs from the simple moving average that weighs all
periods equally - more responsive to trends
Weighted Moving Average
Time Series Models (continued)
• Exponential Smoothing:
Most frequently used time series method because of ease
of use and minimal amount of data needed
• Need just three pieces of data to start:
– (Ft)=the exponentially smoothened forecast for period t
– (Dt)=Actual Demand for period t
– Select value of smoothing coefficient between 0 and 1.0
• If no last period forecast is available, average the last
few periods or use naive method
• Higher values (e.g. .7 or .8) may place too much
weight on last period’s random variation
• lower value of indicates that the forecast is not
responsive to the demand
Causal Models
• Often, leading indicators can help to predict changes in
future demand
• Causal models establish a cause-and-effect relationship
between independent and dependent variables
• A common tool of causal modeling is linear regression:
• Additional related variables may require multiple
regression modeling
Linear Regression
• Identify dependent (y) and
independent (x) variables
• Solve for the slope of the line
• Solve for the y intercept
• Develop your equation for the
trend line
Y=a + bX
Forecast error
Measures of forecast error
MAD
MAD
MSE
MSE
MAPE
MAPE
Summary
