Forecasting

“Prediction is very difficult,

especially if it's about the future.”
Nils Bohr
 Objectives

• Give the fundamental rules of forecasting

• Calculate a forecast using a moving average,

weighted moving average, and exponential
smoothing

• Calculate the accuracy of a forecast

What is forecasting?

Forecasting is a tool used for predicting

future demand based on
past demand information.
Why is forecasting important?

Demand for products and services is usually uncertain.

Forecasting can be used for…
• Strategic planning (long range planning)
• Finance and accounting (budgets and cost controls)
• Marketing (future sales, new products)
• Production and operations
 Forecasting
• Predict the next number in the pattern:

a) 3.7, 3.7, 3.7, 3.7, 3.7, ?

b) 2.5, 4.5, 6.5, 8.5, 10.5, ?

c) 5.0, 7.5, 6.0, 4.5, 7.0, 9.5, 8.0, 6.5, ?

 Forecasting
• Predict the next number in the pattern:

a) 3.7, 3.7, 3.7, 3.7, 3.7, 3.7

b) 2.5, 4.5, 6.5, 8.5, 10.5, 12.5

c) 5.0, 7.5, 6.0, 4.5, 7.0, 9.5, 8.0, 6.5, 9.0

 Forecasting process

independent and Forecast

forecasting objectives
dependent
procedure
variables
Evaluate
Seforecasting analysis performance
method results against the
forecasts
Comprehend total
forecasting procedure Present all the
Make and
assumptions
Collect, collate, finalize the
about data
gather and analyze forecast
data
Types of Forecasts by Time Horizon
Quantitative
• Short-range forecast methods
– Usually < 3 months
• Job scheduling, worker assignments
Detailed
• Medium-range forecast use of
system
– 3 months to 2 years
• Sales/production planning

• Long-range forecast
– > 2 years
Design
• New product planning
of system
Qualitative
Methods
Forecasting During the Life Cycle

Introduction Growth Maturity Decline

Qualitative models Quantitative models

- Executive judgment
- Time series analysis
- Market research
- Survey of sales force - Regression analysis
- Delphi method
Sales

Time
 Forecasting Approaches

• Two basic approaches:

• Top-down or Break-down approach
• Bottom-up or Build-up approach
• Some companies use both approaches to
increase their confidence in the forecast
 Qualitative Forecasting Methods
Qualitative
Forecasting

Models
Sales Delphi
Executive Market
Force Method
Judgement Research/
Composite
Survey

Smoothing
 Qualitative Methods

Briefly, the qualitative methods are:

Executive Judgment: Opinion of a group of high level experts or

managers is pooled

Sales Force Composite: Each regional salesperson provides his/her

sales estimates. Those forecasts are then reviewed to make sure they
are realistic. All regional forecasts are then pooled at the district and
national levels to obtain an overall forecast.

Market Research/Survey: Solicits input from customers pertaining to

their future purchasing plans. It involves the use of questionnaires,
consumer panels and tests of new products and services.
 Qualitative Methods

Delphi Method: As opposed to regular panels where the individuals involved are
in direct communication, this method eliminates the effects of group potential
dominance of the most vocal members. The group involves individuals from
inside as well as outside the organization.

Typically, the procedure consists of the following steps:

Each expert in the group makes his/her own forecasts in form of statements
 The coordinator collects all group statements and summarizes them
 The coordinator provides this summary and gives another set of questions
to each
group member including feedback as to the input of other experts.
 The above steps are repeated until a consensus is reached.

.
 Quantitative Forecasting Methods
Quantitative
Forecasting

Time Series Regression

Models Models

2. Moving 3. Exponential
1. Naive
Average Smoothing
a) simple a) level
b) weighted b) trend
c) seasonality
 Quantitative Forecasting Methods
Quantitative
Forecasting

Time Series Regression

Models Models

2. Moving 3. Exponential
1. Naive
Average Smoothing
a) simple a) level
b) weighted b) trend
c) seasonality
 Time Series Models

• Try to predict the future based on past data

– Assume that factors influencing the past will

continue to influence the future
Time Series Models:
Components

Random Trend

Seasonal Composite
 Product Demand over Time
Demand for product or service

Year Year Year Year

1 2 3 4
 Product Demand over Time
Trend component
Seasonal peaks
Demand for product or service

Actual demand
Random line
variation
Year Year Year Year
1 2 3 4
Now let’s look at some time series approaches to forecasting…
Quantitative Forecasting Methods
Quantitative
Time Series
Models

Models

2. Moving 3. Exponential
1. Naive
Average Smoothing
a) simple a) level
b) weighted b) trend
c) seasonality
 1. Naive Approach

 Demand in next period is the same as demand

in most recent period
 May sales = 48 → June forecast = 48

 Usually not good

 2a. Simple Moving Average

• Assumes an average is a good estimator of future

behavior
– Used if little or no trend
– Used for smoothing

A t + A t -1 + A t -2 + ... + A t -n 1
Ft 1 =
n

Ft+1 = Forecast for the upcoming period, t+1

n = Number of periods to be averaged
A t = Actual occurrence in period t
2a. Simple Moving Average

You’re manager in Amazon’s electronics department.

You want to forecast ipod sales for months 4-6 using a
3-period moving average.
Sales
Month (000)
1 4
2 6
3 5
4 ?
5 ?
6 ?
 2a. Simple Moving Average
You’re manager in Amazon’s electronics department.
You want to forecast ipod sales for months 4-6 using a
3-period moving average.
Sales Moving Average
Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 ? (4+6+5)/3=5
5 ?
6 ?
2a. Simple Moving Average
What if ipod sales were actually 3 in
month 4

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3? 5
5 ?
6 ?
2a. Simple Moving Average
Forecast for Month 5?

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 ? (6+5+3)/3=4.667
6 ?
2a. Simple Moving Average
Actual Demand for Month 5 =
7

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 ?7 4.667
6 ?
2a. Simple Moving Average
Forecast for Month 6?

Sales Moving Average

Month (000) (n=3)
1 4 NA
2 6 NA
3 5 NA
4 3 5
5 7 4.667
6 ? (5+3+7)/3=5
 Exponential Smoothing
• Next Year Sales = a(This Year’s sale)+(1-a)(This
years forecast).
Assume that this years sale were 50,000/- and
this years forecast was 40,000/-. The a in
equation is the smoothing constant. Assume
that a was given of 0.2. The forecast for next
years sale would be?
 Qualitative Methods

Type Characteristics Strengths Weaknesses

Executive A group of managers Good for strategic or One person's opinion
opinion meet & come up with new-product can dominate the
a forecast forecasting forecast

Market Uses surveys & Good determinant of It can be difficult to

research interviews to identify customer preferences develop a good
customer preferences questionnaire

Delphi Seeks to develop a Excellent for Time consuming to

method consensus among a forecasting long-term develop
group of experts product demand,
technological
changes, and
30
•
• a. Toothpaste (Purchase Frequency, Price of the unit, size, market size,
past sales, number of retail outlets)
• b. Ice Cream (Number of retail outlets, seasonality, cyclical variations,
prices of the product, population age below six, ten and fifteen, size of
the assortment)
• c. Wrist Watches (Prices, assortments, variants, population size,
replacement demand, new demand, behavioural intention data of the
target class)
• d. Carbonated soft drink (category (cola vs non cola), seasonality, price
points, retail outlet size, seasonality, past demand and proposed
advertising expenditure)
•
• e. Ball bearings (Past sales, current market programs, sectoral
growth rate, percentage of lost customer and prices of the
assortments)
• f. Engine Oil (Government regulation, growth in the automobile
industry, entry of new competitor, changes in the competitor’s
marketing strategy and prices of the substitutes)
• g. Domestic Tourism (Holiday pattern, government’s provision for
the leave travel concession, tourist flow in last years and season by
season data, the destination mix, the growth in infrastructure and
other facilities in the area.