Chapter 8 Forecasting

(Not the full chapter, just the included part)

1. PRINCIPLES OF FORECASTING
There are many types of forecasting models. They differ in their
-Degree of complexity
-The amount of data they use
-The way they generate the forecast
However, some features are common to all forecasting models.
They include the following:
1. Forecasts are rarely perfect. Forecasting the future involves uncertainty. Therefore, it is
almost impossible to make a perfect prediction. Forecasters know that they have to live with a
certain amount of error, which is the difference between what is forecast and what actually
happens. The goal of forecasting is to generate good forecasts on the average over time and to
keep forecast errors as low as possible.

2. Forecasts are more accurate for groups or families of items rather than for individual
items. When items are grouped together, their individual high and low values can cancel each
other out. The data for a group of items can be stable even when individual items in the group
are very unstable. Consequently, one can obtain a higher degree of accuracy when forecasting
for a group of items rather than for individual items. For example, you cannot expect the same
degree of accuracy if you are forecasting sales of green polo shirts that you can expect when
forecasting sales of all polo shirts.

3. Forecasts are more accurate for shorter than longer time horizons. The shorter the time
horizon of the forecast, the lower the degree of uncertainty. Data do not change very much in
the short run. As the time horizon increases, however, there is a much greater likelihood that
changes in established patterns and relationships will occur. Because of that, forecasters cannot
expect the same degree of forecast accuracy for a long-range forecast as for a short-range
forecast. For example, it is much harder to predict sales of a product two years from now than to
predict sales two weeks from now.

2. STEPS IN THE FORECASTING PROCESS (5 steps)

Regardless of what forecasting method is used, there are some basic steps that should be
followed when making a forecast:

1. Decide what to forecast. Remember that forecasts are made in order to plan for the future.
To do so, we have to decide what forecasts are actually needed. This is not as simple as it
sounds. For example, do we need to forecast sales or demand? These are two different things,
and sales do not necessarily equal the total amount of demand for the product.

An important part of this decision is the level of detail required for the forecast Examples:
Product or product group, units, boxes, or dollars of the forecast, and the time horizon Monthly
or quarterly

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2. Evaluate and analyze appropriate data. This step involves identifying what data are
needed and what data are available. This will have a big impact on the selection of a
forecasting model. For example, if you are predicting sales for a new product, you may not have
historical sales information, which would limit your use of forecasting models that require quantitative
data

We will also see in this chapter that different types of patterns can be observed in the data. It is
important to identify these patterns in order to select the correct forecasting model.
For example, if a company was experiencing a high increase in product sales for the past year, it
would be important to identify this growth in order to forecast correctly.

3. Select and test the forecasting model. Once the data have been evaluated, the next step is
to select an appropriate forecasting model. As we will see next, there are many models to
choose from. Usually we consider factors like cost and ease of use in selecting a model.
Another very important factor is accuracy. A common procedure is to narrow the choices to
two or three different models and then test them on historical data to see which one is most
accurate.

4. Generate the forecast. Once we have selected a model, we use it to generate the forecast.
But we are not finished, as you will see in the next step.

5. Monitor forecast accuracy. Forecasting is an ongoing process.

After we have made a forecast, we should record what actually happened. We can then use that
information to monitor our forecast accuracy. This process should be carried out continuously
because environments and conditions often change.

-What was a good forecasting model in the past might not provide good results for the future. -
-We have to constantly be prepared to revise our forecasting model as our data change.

3. TYPES OF FORECASTING METHODS

Forecasting methods can be classified into two groups: qualitative and quantitative.

Qualitative forecasting methods (often called judgmental methods)

Are methods in which the forecast is made subjectively by the forecaster.
They are educated guesses by forecasters or experts based on intuition, knowledge, and experience.

-When you decide, based on your intuition, that EL-Zamalek is going to win a football match, you
are making a qualitative forecast.

-Because qualitative methods are made by people, they are often biased. These biases can be related to
personal motivation (They are going to set my budget based on my forecast, so Id better predict
high.), mood (I feel lucky today!), or conviction (That pitcher can strike anybody out!).

Quantitative forecasting methods are based on mathematical modeling. Because they are
mathematical, these methods are consistent.
-The same model will generate the exact same forecast from the same set of data every time.
-These methods are also objective. They do not suffer from the biases found in qualitative forecasting.

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Finally, these methods can consider a lot of information at one time. Because people have limited
information-processing abilities and can easily experience information overload, they cannot compete
with mathematically generated forecasts in this area.

Both qualitative and quantitative forecasting methods have strengths and weaknesses.
Although quantitative methods are objective and consistent, they require data in quantifiable form in
order to generate a forecast. Often, we do not have such data.

Also, Quantitative methods are only as good as the data on which they are based.
Qualitative methods, on the other hand, have the advantage of being able to incorporate last-minute
inside information in the forecast, such as an advertising campaign by a competitor, a snowstorm
delaying a shipment, or a heat wave increasing sales of ice cream.

Each method has its place, and a good forecaster learns to rely on both.

Lets discuss Qualitative Methods in details.

Qualitative Methods There are many types of qualitative forecasting methods, some informal
and some structured.

-Regardless of how structured the process is, however, remember that these models are based
on subjective opinion and are NOT mathematical in nature.

3 common qualitative methods:

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1. Executive Opinion is a forecasting method in which a group of managers meet and
collectively develop a forecast.

This method is often used for strategic forecasting or forecasting the success of a new product
or service and sometimes it can be used to change an existing forecast to account for unusual
events such as an unusual business cycle or unexpected competition.

Although managers can bring good insights to the forecast, this method has a number of
disadvantages
- Often the opinion of one person can dominate the forecast if that person has more power than
the other members of the group or is very domineering.

2. Market Research (see the photo) is an approach that uses surveys and interviews to
determine customer likes, dislikes, and preferences and to identify new-product ideas.

-Usually, the company hires an outside marketing firm to conduct a market research study.
For example: Someone called you and asked about your product preferences as customer.

-Market research can be a good determinant of customer preferences. However, it has a

number of disadvantages.
-It can be difficult to develop a good questionnaire (how the survey questions are designed).
-Designing a poor questionnaire can lead to misinterpretation of the survey results.

3. The Delphi Method is a forecasting method in which the objective is to reach a consensus
among a group of experts while maintaining their anonymity.

- The researcher puts together a panel of experts in the chosen field. These experts do not have
to be in the same facility or even in the same country. They do not know who the other
panelists are.

- The process involves sending questionnaires to the panelists, then summarizing the findings
and sending them an updated questionnaire incorporating the findings. This process continues
until a consensus is reached.

The idea behind the Delphi method is that a panel of experts in a particular field might not
agree on certain things, but what they do agree on will probably happen.

The researchers job is to identify what the experts agree on and use that as
the forecast. This method has the advantage of not allowing anyone to
dominate the consensus, and it has been shown to work very well. Although
it takes a large amount of time (Disadvantage), it has been shown to be an
excellent method for forecasting long-range product demand, technological
change, and scientific advances in medicine. For example, if you wished to
predict the timing for an AIDS vaccine or a cure for cancer, you would
probably use this technique.

Market research being conducted in a

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shopping mall.