FORECASTING

DEMANDS
 Forecasting is the art and science of predicting future
events. Forecasting may involve taking historical data
and projecting them into the future with some sort of
mathematical model. It may be a subjective or intuitive
prediction. Or it may involve a combination of these –
that is, a mathematical model adjusted by a manager’s
good judgment.
 What is forecasting?

Everyday, managers make decisions without knowing

what will happen in the future. They order inventory
without knowing what sales will be, purchase new
equipment despite uncertainty about demand for
products, and make investments without knowing what
profits will be. Managers are always trying to make
better estimates of what will happen in the future in the
face of uncertainty. Making good estimates is the main
purpose of forecasting.
 Forecasting time horizons
A forecast is usually classified by the future time
horizon that it covers. Time horizons fall into three
categories;

1. Short-range forecast:
This forecast has a time span of up to 1 year but is
generally less than 3 months. It is used for planning
purchasing, job scheduling, workforce levels, job
assignments, and production levels.
2. Medium-range forecast: A medium-range, or
intermediate, forecast generally spans from 3 months to
3 years. It is useful in sales planning, production
planning and budgeting, cash budgeting, and analysis of
various operating plans. Both time series and casual
methods are use.
3. Long-range forecast: Generally 3 years or more in
time span, long-range forecasts are used in planning for
new products, capital expenditures, facility location or
expansion, and research and development.
 The influence of Product Life Cycle
Another factor to consider when developing sales
forecasts, especially longer ones, is product life cycle.
Products, and even services, do not sell at a constant
level throughout their lives. Most successful products
pass through four stages: (1) Introduction, (2) Growth,
(3) Maturity, and (4) Decline.
Products in the first two stages of the life cycle need
longer forecasts than those in the maturity and decline
stages. Forecasts that reflect life cycle are useful in
projecting different staffing levels, inventory levels, and
factory capacity as the product passes from the first to
the last stage.
 Types of forecasts
Organizations use three major types of forecasts in planning
future operations:
1. Economic forecasts address the business cycle by predicting
inflation rates, money supplies, housing starts, and other
planning indicators.
2. Technological forecasts are concerned with rates of
technological progress, which can result in the birth of
exciting new products, requiring new plants and equipment.
3. Demand forecasts are projections of demand for a
company’s products or services. These forecasts, also called
sales forecasts, drive a company’s production, capacity, and
scheduling systems and serve as inputs to financial,
marketing, and personnel planning.
The strategic importance of forecasting
Good forecasts are of critical importance in all aspects
of a business: The forecast is the only estimate of
demand until actual demand becomes known. Forecasts
of demand therefore drive decisions in many areas. The
impact of product demand forecast on three activities:
(1) human resources, (2) capacity, and (3) supply-chain
management.
 Human Resources
Hiring, training, and laying off workers all depend on
anticipated demand. If the human resources department
must hire additional workers without warning, the
amount of training declines and the quality of the
workforce suffers. A large Louisiana chemical firm
almost lost its biggest customer when a quick expansion
to around-the-clock shifts led to a total breakdown in
quality control on the second and third shifts.
 Capacity
When capacity is inadequate, the resulting shortages
can lead to loss of customers and market share. This is
exactly what happened to Nabisco when it
underestimated the huge demand for its new low-fat
Snackwell Devil’s Food Cookies. Even with production
lines working overtime, Nabisco could not keep up
with demand, and it lost customers.
 Supply-Chain Management
Good supplier relations and the ensuing price
advantages for materials and parts depend on accurate
forecasts.
Seven steps in the forecasting system
Forecasting follows seven basic steps
1. Determine the use of the forecast: staffing, opening times, ride
availability, and food supplies.
2. Select the items to be forecasted: A forecast of daily attendance
at each is the main number that determines labor, maintenance,
and scheduling.
3. Determine the time horizon of the forecast: Is it short, medium,
or long term? Disney develops daily, weekly, monthly, annual,
and 5-year forecasts.
4. Select the forecasting model(s): Disney uses a variety of statistical models,
including moving averages, econometrics, and regression analysis. It also employs
judgmental, or nonquantitative models.
5. Gather the data needed to make the forecast: Disney’s forecasting team
employs 35 analysts and 70 field personnel to survey 1 million people/businesses
every year.
6. Make the forecast
7. Validate and implement the results:
Forecasting approaches
There are two general approaches to forecasting. One is
a quantitative analysis; the other is a qualitative
approach. Quantitative forecasts use a variety of
mathematical models that rely on historical data and/or
associative variables to forecast demand. Qualitative
forecasts incorporate such factors as the decision
maker’s intuition, emotions, personal experiences, and
value system in reaching a forecast. Some firms use one
approach and some use the other. In practices, a
combination of the two is usually most effective
 Overview of Qualitative Methods
In this section, we consider four different qualitative
forecasting techniques:
1. Jury of executive opinion: Under this method, the
opinions of a group of high-level experts or managers,
often in combination with statistical models, are
pooled to arrive at a group estimate of demand.
Bristol-Myers Squibb company, for example, uses 220
well-known research scientists as its jury of executive
opinion to get a grasp on future trends in the world of
medical research.
2. Delphi method: There are three different types of
participants in the Delphi method: decision makers, staff
personnel, and respondents. Decision makers usually
consist of a group of 5 to 10 experts who will be making
the actual forecast. Staff personnel assist decision makers
by preparing, distributing, collecting, and summarizing a
series of questionnaires and survey results. The
respondents are a group of people, often located in
different places, whose judgments are valued. This group
provides inputs to the decision makers before the forecast
is made.
3. Sales force composite: in this approach, each
salesperson estimates what sales will be in his or her
region. These forecasts are then reviewed to ensure that
they are realistic. Then they are combined at the district
and national levels to reach an overall forecast. A
variation of this approach occurs at Lexus, where every
quarter Lexus dealers have a “make meeting”. At this
meeting, they talk about what is selling, in what colors,
and with what options, so the factory knows what to
build.
4. Consumer market survey: This method solicits input
from customers or potential customers regarding future
purchasing plans. It can help not only in preparing a forecast
but also in improving product design and planning for new
products. The consumer market survey and sales force
composite methods can, however, suffer from overly
optimistic forecasts that arise from customer input.
 Overview of Quantitative Methods
Five quantitative forecasting methods, all of which use
historical data. They fall into two categories:
1. Naïve approach
2. Moving averages time-series
3. Exponential smoothing models
4. Trend projection
5. Linear regression associative model
Time-Series Models – predict on the assumption that
the future is a function of the past. In other words, they
look at what has happened over a period of time and use
a series of past data to make a forecast.
Associative Models – such as linear regression,
incorporate the variables or factors that might
influence the quantity being forecast. For example, an
associative model for lawn mower sales might use
factors such as new housing starts, advertising budget,
and competitor’s prices.
 Decomposition of a time series
Analyzing time series means breaking down past data
into components and then projecting them forward. A
time series has four components:
1. Trend is the gradual upward or downward movement
of the data over time. Changes in income,
population, age distribution, or cultural views may
account for movement in trend.
2. Seasonality is a data pattern that repeats itself after a
period of days, weeks, months, or quarters. There are
six common seasonality patterns:

Restaurants and barber shops, for example, experience weekly

seasons, with Saturday being the peak of business. Beer
distributors forecast yearly patterns, with monthly seasons.
Three “seasons”- May, July, and September – each contain a big
beer-drinking holiday.
3. Cycles are patterns in the data that occur every
several years. They are usually tied into the business
cycle and are of major importance in short-term
business analysis and planning. Predicting business
cycles is difficult because they may be affected by
political events or by international turmoil.
4. Random variations are “blips” in the data caused by
chance and unusual situations. They follow no
discernible pattern, so they cannot be predicted