BME 1(Operations Management & TQM)

FORECASTING

Activity 3.1- Questions

Instruction: Answer the questions below. Make your answer simple, clear and relevant. Submit
your answer through google class. You may encode your answer or write it in a white
pad/coupon or in your notebook.

1. What is forecasting?
The demand forecasts set the agenda for how the entire company will use its people,
commit its resources, call on outside suppliers, and plan its work schedules. Forecasts
provide information to coordinate demands for products and services with supplies of
resources that are required to meet the demands. As such, the forecast is the platform for
future planning.

2. What is the purpose of the forecasts? For what decisions will they be used?
There are two uses for forecasts. One is to help managers plan the system, and
the other is to help them plan the use of the system. Planning the system generally
involves long-range plans about the types of products and services to offer, what facilities
and equipment to have, where to locate, and so on. Planning the use of the system refers
to short-range and intermediate-range planning, which involve tasks such as planning
inventory and workforce levels, planning purchasing and production, budgeting, and
scheduling.
Thus, forecasting will be used for budgeting, planning, and estimating future growth.

3. Describe the following methods of forecasting.

a. Qualitative method
Qualitative methods consist mainly of subjective inputs, which often defy precise
numerical description.

- Executive opinion
• A small group of upper-level managers (e.g., in marketing, operations, and
finance) may meet and collectively develop a forecast.
• often used as a part of long-range planning and new product development.
• has the advantage of bringing together the considerable knowledge and talents
of various managers.
• risks that view of one person will prevail, and the possibility that diffusing
responsibility for the forecast over the entire group may result in less pressure to
produce a good forecast.

- Salesforce opinions
Members of the sales staff or the customer service staff are often good sources of
information because of their direct contact with consumers. They are often aware
of any plans the customers may be considering for the future.
 Disadvatages: staff members may be unable to distinguish between what
customers would like to do and what they actually will do, people are sometimes
overly influenced by recent experiences, after several periods of low sales, their
estimates may tend to become pessimistic, after several periods of good sales,
they may tend to be too optimistic, if forecasts are used to establish sales quotas,
there will be a conflict of interest because it is to the salesperson’s advantage to
provide low sales estimates

- Consumer surveys
Soliciting inpit from consumers that ultimately determine demand. Because there
is too many costumers, organizations seeking consumer input usually resort to
consumer surveys, which enable them to sample consumer opinions.
Advantage: tap information that might not be available elsewhere
A considerable amount of knowledge and skill is required to construct a survey,
administer it, and correctly interpret the results for valid information.
Disadvatage: expensive, time consuming, even under the best conditions, surveys
of the general public must contend with the possibility of irrational behavior
patterns.

- Delphi method
an iterative process intended to achieve a consensus forecast. This method
involves circulating a series of questionnaires among individuals who possess the
knowledge and ability to contribute meaningfully. Responses are kept
anonymous, which tends to encourage honest responses and reduces the risk that
one person’s opinion will prevail. Each new questionnaire is developed using the
information extracted from the previous one, thus enlarging the scope of
information on which participants can base their judgments.

b. Quantitative method
Involve either the projection of historical data or the development of associative
models that attempt to utilize causal (explanatory) variables to make a forecast.

- Time series
a time-ordered sequence of observations taken at regular intervals (e.g., hourly,
daily, weekly, monthly, quarterly, annually). The data may be measurements of
demand, earnings, profits, shipments, accidents, output, precipitation,
productivity, or the consumer price index. Forecasting techniques based on time-
series data are made on the assumption that future values of the series can be
estimated from past values.

 Naïve methods
Uses a single previous value of a time series as the basis of a forecast. The
naive approach can be used with a stable series (variations around an
average), with seasonal variations, or with trend. With a stable series, the
last data point becomes the forecast for the next period.
  Moving average
Uses a number of the most recent actual data values in generating a
forecast.
Formula: Ft=MAn=At-n+...+At-2+At-1/n
Ft - forecast for time period t
MAn - n period moving average
At-i - actual value in period t – i
n = number of periods (data points) in the moving average

 Weighted moving average

Similar to moving average, except that it typically assigns more weight to
the most recent values in a time series.
Formula: Ft = Wt – n (At – n) + … + Wt – 2 (At – 2) + Wt – 1 (At – 1) +
… + Wt – n (At – n)
Wt – 1 = weight for period t – 1, etc.
At – 1 = actual value for period t – 1, etc.

 Exponential smoothing
A sophisticated weighted averaging method that is still relatively easy to
use and understand. Each new forecast is based on the previous forecast
plus a percentage of the difference between that forecast and the actual
value of the series at that point.
Formula: Next Forecast = Previous Forecast + α (Actual – Previous
Forecast)
(Actual – Previous Forecast) = represents the forecast error and α is a
percentage of the error.
Or:
Ft = Ft – 1 + α (At – 1 – Ft – 1)
Ft = forecast for period t
Ft – 1 = forecast for the previous period (period t – 1)
α = is the smoothing constant
At – 1 = Actual demand or sales for the previous period

- Regression analysis
Useful for establishing a relationship between two sets of numbers that are time
series. The first assumption that is generally made in regression analysis is that
the relationship between the correlate pairs is linear. It is the easiest assumption to
check. However, if nonlinear relations are hypothesized, there are strong, but
more complex methods for doing nonlinear regression analyses.
✔ X is the independent variable
✔ Y is the dependent variable.
Formula: Y = a + bX
 a - intercept on the Y-axis which is the value of the demand (variable Y ) when X
=0
b - slope of the line which gives the change in the value of demand (variable Y )
for a unit change in the value of X. That is, b is the amount by which demand will
change if the independent variable changes by one unit.

- Other methods
 Focus forecasting
♡ Forecasts based on a “best recent performance” basis.
♡ Developed by Bernard T. Smith, and is described in several of his
books.
♡ Involves the use of several forecasting methods (e.g., moving average,
weighted average, and exponential smoothing) all being applied to the last
few months of historical data after any irregular variations have been
removed.
♡ Has the highest accuracy is then used to make the forecast for the next
month.
♡ This process is used for each product or service, and is repeated
monthly.

 Diffusion models
Generative model - used to generate data similar to the data on which they
are trained.
A theory that demonstrates how individuals and large groups get adapted
to new ideas and innovations. When new products or services are
introduced, historical data are not generally available on which to base
forecasts. Instead, predictions are based on rates of product adoption and
usage spread from other established products, using mathematical
diffusion models. These models take into account such factors as market
potential, attention from mass media, and word of mouth.
Diffusion models are widely used in marketing and to assess the merits of
investing in new technologies.

4. What factors are considered when selecting a method of forecasting?

The factors to consider when selecting a method of forecasting are:
▪ Cost and accuracy. The higher the accuracy, the higher the cost, so it is important to
weigh cost–accuracy trade-offs carefully. The best forecast is not necessarily the most
accurate or the least costly; rather, it is some combination of accuracy and cost deemed
best by management.
▪ Availability of historical data; the availability of computer software; and the time
needed to gather and analyse data and to prepare the forecast. The forecast horizon is
important because some techniques are more suited to long-range forecasts while others
work best for the short range. For example, moving averages and exponential smoothing
are essentially short-range techniques, since they produce forecasts for the next period.
Trend equations can be used to project over much longer time periods. When using
timeseries data, plotting the data can be very helpful in choosing an appropriate method.
Several of the qualitative techniques are well suited to long-range forecasts because they
do not require historical data. The Delphi method and executive opinion methods are
often used for long-range planning. New products and services lack historical data, so
forecasts for them must be based on subjective estimates. In many cases, experience with
similar items is relevant.
In some instances, a manager might use more than one forecasting technique to obtain
independent forecasts. If the different techniques produced approximately the same
predictions, that would give increased confidence in the results; disagreement among the
forecasts would indicate that additional analysis may be needed.