It is the process of predicting future events. By using various Qualitative and Quantitative methods.

Underlying basis of all business decisions : Production, inventory etc.

Forecasting Time Horizon

On the basis of time horizon, Forecasting is of three types : Short Range Forecast:

Time span up to one year but generally less than 3 months. This forecast is used for planning, purchasing, job scheduling , job assignment and determining the production level etc.

Medium Range Forecast : Intermediate forecast ranging from 3 months to 3 years. Useful for the purposes : Sales planning, production planning and budgeting analysis of various operational plans. Long Range Forecast : It is 3 years or more in time span. This forecast is used for the purposes like : planning for the new product, capital expenditure, facility location, Research and Development etc.

Difference between Short Range and Long Range Forecasting

Short Range forecasting employs quantitative

techniques for production. It uses the techniques like :

Moving average method, Exponential smoothing Trend extrapolation etc.

Short term forecast is more accurate as it is for small

time horizon. Long range forecast deals with more comprehensive issues and support management decisions regarding planning and products, plants and processes.

Types of Forecast
Forecasting can be categorised as : Economic Forecast Technological Forecast Demand Forecast

Economic Forecast
It addresses the business cycle by predicting various

features like :
Inflation rates Money supply etc.

It is helpful for the organisation to prepare medium and long term forecast.

Technological Forecast
These are concerned with technological progress

which result in the birth of executing a new product.

Predict rate of technological progress Impacts development of new products

Long term forecast are concerned with the rate of

technological forecast.

Demand Forecast
Predict sales of existing products and services
These are useful for the projection of demand for a

companys product or services over a period of time. Companys Production Capacity Scheduling System serve as an input to financial, marketing and personal planning.
Demand forecasting that is the estimation of demand is must in the introductory phase of a product.

Strategic importance of Forecasting

Good forecast are of critical importance in all aspects

of a business. Forecast is the only estimate of demand until actually demand became known. Product forecast have impacts on several activities of an organisation like:
Human Resources Capacity

Supply Chain Management

Human Resources
Hiring , training and laying off workers : these all

depends upon the anticipated demand.

Demand forecast is the determinant for the decisions like : Hiring and training etc.

Capacity
Inadequate capacity/capacity shortage of an

organisation results in the factors like ;

Loss of customers Loss of Market Undependable delivery

Supply Chain Management

Good Supplier relationship
Price advantage for material

Depends upon the accurate forecast. As extensive components of Boeing 787 jets are manufactured in dozens of countries Coordination driven by forecast is essential

Seven Steps in Forecasting System

Determine the use of forecast. Select the item to forecasting. Determine time horizon of forecast. Select the forecasting models. Gather the data needed to make the forecast. Make the Forecast. Validate and implement the result.

These steps present a systemic way of initiating,

designing and implementing forecast.

Forecasting approach
Qualitative Method Used when situation is vague and little data exist. It is used for the

New product and new technology _ going to be introduced. It involve : intuition , personal experience and value system in reaching a forecast.

Quantitative Method Used when situation is stable and historical data exist of the existing product and current technology. Forecast that employee one or more mathematical techniques. Such as sales of LCD and LED televisions by LG.

An Overview of the qualitative Methods

Jury or Executive opinion

Delphi Method
Sales Force Composite Customer Market Survey

Jury of Executive Opinion

Sales Force Composite

Delphi Method
Iterative group process,

continues until consensus is reached 3 types of participants Decision makers Staff Staff (Administering survey) Respondents

Decision Makers (Evaluate responses and make decisions)

Respondents (People who can make valuable judgments)

Consumer Market Survey

Overview of Quantitative Approaches

1. Naive approach 2. Moving averages 3. Exponential smoothing 4. Trend projection 5. Linear regression

TimeSeries Model Associative Model

 A Technique that uses a series of past data points to

make a forecast. It require Set of evenly spaced (weekly, monthly, quarterly) numerical data
Assumes that factors influencing past and present will

continue influence in future

Forecast based only on past values, no other variables

important
Obtained by observing response variable at regular time

periods

Time Series Components/Decomposition of Time series

Trend Cycles

Seasonal

Random

Trend Component

It is the gradual upward or downward movement of data over time. Changes due to population, technology, age, culture, etc.

Seasonal Component

It is the data pattern that repeats itself after a period of days, weeks, months or quarter. Due to weather, customs, etc. Occurs within a single year . There are six common seasonality pattern

Period
Week Month Month Year Year Year

Length
Day Week Day Quarter Month Week

Number of Seasons 7 4-4.5 28-31 4 12 52

Cyclical Component

Cycles are the pattern in which data that occur every several years. Repeating up and down movements Affected by business cycle, political, and economic factors Often causal or associative relationships

10

15

20

Random Component
These are the blips in the data caused by an unusual situation. Erratic, unsystematic, residual fluctuations

Due to random variation or unforeseen events

They follow no discernible

pattern, so cant be predicted.

Components of Demand
Trend component
Demand for product or service

Seasonal peaks

Actual demand Average demand over four years

| 3 Year | 4
Figure 4.1

Random variation
| 1 | 2

Naive Approach

Moving Average Method

A forecasting method that uses an average of the n most recent period. Used if little or no trend Used often for smoothing
Provides overall impression of data over time

Moving Average Example

Graph of Moving Average

Moving Average Forecast 30 28 26 24 22 20 18 16 14 12 10 | | Actual Sales

Shed Sales

Weighted Moving Average

Weighted Moving Average

Potential Problems With Moving Average

Exponential Smoothing

Exponential Smoothing

Choosing
The objective is to obtain the most accurate forecast no matter the technique.
We generally do this by selecting the model that gives us the lowest forecast error

Common Measures of Error

MAD =

Mean Squared Error (MSE)

MSE =

Comparison of Forecast Error

Quarter Actual Tonnage Unloaded Rounded Forecast with = .10 Absolute Deviation for = .10 Rounded Forecast with = .50 Absolute Deviation for = .50

1 2 3 4 5 6 7 8

180 168 159 175 190 205 180 182

175 175.5 174.75 173.18 173.36 175.02 178.02 178.22

5.00 7.50 15.75 1.82 16.64 29.98 1.98 3.78 82.45

175 177.50 172.75 165.88 170.44 180.22 192.61 186.30

5.00 9.50 13.75 9.12 19.56 24.78 12.61 4.30 98.62

Comparison of Forecast Error

MAD = Actual
Quarter

|deviations| Rounded Absolute

Forecast n with = .10

1 2 3 4 5 6 7 8

For = .10 180 175 5.00 168 = 82.45/8 175.5 = 10.31 7.50

Tonnage Unloaded

Deviation for = .10

Rounded Forecast with = .50

Absolute Deviation for = .50

For

159 175 = .50 190 205 = 180 182

174.75 173.18 173.36 98.62/8 175.02 178.02 178.22

15.75 1.82 16.64 12.33 29.98 1.98 3.78 82.45

175 177.50 172.75 165.88 170.44 180.22 192.61 186.30

5.00 9.50 13.75 9.12 19.56 24.78 12.61 4.30 98.62

Comparison of Forecast Error (forecast errors)

MSE =
1 2 3 4 5 6 7 8
Quarter

For = .10 180 175 5.00 168 175.5 = 190.82 7.50 = 1,526.54/8

Actual Tonnage Unloaded

Rounded Forecast n with = .10

2 Absolute Deviation for = .10

Rounded Forecast with = .50

Absolute Deviation for = .50

For

159 174.75 175 = .50 173.18 190 173.36 = 1,561.91/8 205 175.02 = 180 178.02 182 178.22 MAD

15.75 1.82 16.64 195.24 29.98 1.98 3.78 82.45 10.31

175 177.50 172.75 165.88 170.44 180.22 192.61 186.30

5.00 9.50 13.75 9.12 19.56 24.78 12.61 4.30 98.62 12.33

Comparison of Forecast Error

Quarter Actual Tonnage Unloaded Rounded Forecast with = .10 Absolute Deviation for = .10 Rounded Forecast with = .50 Absolute Deviation for = .50

1 2 3 4 5 6 7 8

180 168 159 175 190 205 180 182

175 175.5 174.75 173.18 173.36 175.02 178.02 178.22 MAD MSE MAPE

5.00 7.50 15.75 1.82 16.64 29.98 1.98 3.78 82.45 10.31 190.82 5.59%

175 177.50 172.75 165.88 170.44 180.22 192.61 186.30

5.00 9.50 13.75 9.12 19.56 24.78 12.61 4.30 98.62 12.33 195.24 6.76%

Trend Projections
Fitting a trend line to historical data points to project into the medium to long-range

Linear trends can be found using the least squares technique

y = a + bx
where^ y = computed value of the variable to be predicted (dependent variable) a = y-axis intercept b = slope of the regression line x = the independent variable ^

Least Squares Method

Values of Dependent Variable
Actual observation (y value)
Deviation5 Deviation3 Deviation4 Deviation1 (error)

Deviation7

Deviation6

Deviation2

Trend line, y^ = a + bx

Time period

Figure 4.4

Least Squares Method

Values of Dependent Variable
Actual observation (y value)
Deviation5 Deviation3

Deviation7

Deviation6

Least squares method minimizes the sum of the squared errors (deviations)
Deviation4

Deviation1 Deviation2

Trend line, y^ = a + bx

Time period

Figure 4.4

Least Squares Method

Equations to calculate the regression variables
y = a + bx b= Sxy - nxy Sx2 - nx2
^

a = y - bx

Least Squares Example

Year
2001 2002 2003 2004 2005 2005 2007 Time Period (x) 1 2 3 4 5 6 7 x = 28 x=4 Electrical Power Demand 74 79 80 90 105 142 122 y = 692 y = 98.86

x2
1 4 9 16 25 36 49 x2 = 140

xy
74 158 240 360 525 852 854 xy = 3,063

xy - nxy b= = 2 2 x - nx

3,063 - (7)(4)(98.86) = 10.54 140 - (7)(42)

a = y - bx = 98.86 - 10.54(4) = 56.70

Least Squares Example

Year
1999 2000 The 2001 2002 2003 2004 2005 Time Period (x) Electrical Power Demand

x2
1 4 9 16 25 36 49 Sx2 = 140

xy
74 158 240 360 525 852 854 Sxy = 3,063

1 74 2 79 trend 3 line is 80 4 90 ^ 5 56.70 + 10.54x 105 y= 6 142 7 122 Sy = 692 y = 98.86

Sx = 28 x=4

Sxy - nxy b= = 2 2 Sx - nx

3,063 - (7)(4)(98.86) = 10.54 140 - (7)(42)

a = y - bx = 98.86 - 10.54(4) = 56.70

Associative Forecasting
Used when changes in one or more independent variables can be used to predict the changes in the dependent variable Most common technique is linear regression analysis

Associative Forecasting
Forecasting an outcome based on predictor variables using the least squares technique y = a + bx
where^ y = computed value of the variable to be predicted (dependent variable) a = y-axis intercept b = slope of the regression line x = the independent variable though to predict the value of the dependent variable ^

Associative Forecasting Example

Sales ($ millions), y 2.0 3.0 2.5 2.0 2.0 3.5 Local Payroll ($ billions), x 1 3 4 4.0 2 1 3.0 7
Sales 2.0 1.0 0 | 1 | 2 | | | 3 4 5 Area payroll | 6 | 7

Associative Forecasting Example

Sales, y
2.0 3.0 2.5 2.0 2.0 3.5 y = 15.0
x = x/6 = 18/6 = 3

Payroll, x
1 3 4 2 1 7 x = 18
b=

x2
1 9 16 4 1 49 x2 = 80

xy
2.0 9.0 10.0 4.0 2.0 24.5 xy = 51.5 51.5 - (6)(3)(2.5) = .25 80 - (6)(32)

xy - nxy = x2 - nx2

y = y/6 = 15/6 = 2.5

a = y - bx = 2.5 - (.25)(3) = 1.75

Associative Forecasting Example

y = 1.75 + .25x
If payroll next year is estimated to be $6 billion, then: ^

Sales = 1.75 + .25(payroll)

4.0 Sales 3.25 3.0 2.0 1.0 0 | 1 | 2 | | | 3 4 5 Area payroll | 6 | 7

Sales = 1.75 + .25(6) Sales = $3,250,000