CHAPTER 4

FORECASTING

INTRODUCTION

FORECAST –. A statement about the future value of a variable of interest Forecast are

a basic input in the decision making processes of operations management because

they provide information on future demand.

 The importance of forecasting to operations management cannot be overstated.

The primary goal of operations management is to match supply to demand.

 Having a forecast of demand is essential for determining how much capacity or

supply will be needed to meet demand.

 Forecast are the basis for budgeting, planning, capacity, sales, production and

inventory, personnel, purchasing and more.

 Forecasts play an important role in the planning process because they enable

managers to anticipate the future so they can plan accordingly.

Two Aspects of Forecast

1. The expected level of demand can be a function of some structural variations,

such as a trend or seasonal variation.

2. The degree of accuracy that can be assigned to forecast. Forecast accuracy is a

function of the ability of forecasters to correctly model demand, random variation,

and sometimes unforeseen events.

 SHORT-TERM FORECAST – pertain to ongoing operations. The time horizon

maybe fairly short or somewhat longer.

 LONG RANGE FORECAST – pertain to new product or services, new

equipment, new facilities, or something else that require a somewhat long lead

time to develop, construct, or otherwise implement.

Here are some examples of uses of forecasts in business organizations;

1. ACCOUNTING – new product/process cost estimates, profit projections, cash

management.
2. FINANCE – equipment/equipment replacement need, timing and amount of

funding/borrowing needs.

3. HUMAN RESOURCES – hiring activities, including recruitment, interviewing,

training, layoff planning, including outplacement counseling.

4. MARKETING – pricing and promotion, e-business strategies, global competition

strategies.

5. MIS – new/revised information systems, internet services

6. OPERATIONS – schedules, capacity planning, work assignments and workloads,

inventory planning, make-or-buy decisions, outsourcing, project management.

7. PRODUCT/SERVICE DESIGN – revision of current features, design of new

products or services.

FORECASTING is also an important component of yield management, which relates

to the percentage of capacity being used. Accurate forecasts can help managers plan

tactics to match capacity with demand, thereby achieving high yield levels.

TWO USES FOR FORECASTS:

o One is to help managers plan the system. Planning the system generally

involves long range plans about the types of products and services to offer, what

facilitates and equipment to have, where to locate, and so on.

o To help them plan the use of the system. Planning the use of the systems

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.

FEATURES COMMON TO ALL FORECASTS

A wide variety of forecasting techniques are in use. In many respects, they are

quite different from each other, as you shall soon discover. Nonetheless, certain

features are common to all, and it is important to recognize them.

1. Forecasting techniques generally assume that the same underlying casual

system that existed in the past will continue to exist in the future.
2. Forecasts are not perfect; actual results usually differ from predicted values; the

presence of randomness precludes a perfect forecast.

3. Forecast for groups of items tend to be more accurate that forecasts for

individual items because forecasting errors among items in a group usually have

a canceling effect.

4. Forecast accuracy decreases as the time period covered by the forecast – the

time horizon increases.

ELEMENTS OF A GOOD FORECAST

1. The forecast should be timely

2. The forecast should be reliable

3. The forecast should be expressed in meaningful units

4. The forecast should be in writing

5. The forecast should be simple to understand and use

6. The forecast should be cost-effective

STEPS IN FORECASTING PROCESS

1. Determine the purpose of the forecast

2. Establish time horizon

3. Select a forecasting techniques

4. Obtain, clean, and analyze appropriate data

5. Make the forecast

6. Monitor the forecast

FORECAST ACCURACY

Accuracy and control forecasts are a vital aspect for forecasting, so forecasters

want to minimize forecast errors.

Forecast errors is the difference between the value that occurs and the value that

was predicted for a given time period. Hence, Error = Actual – Forecast:

e t = At – Ft

o Positive errors results when the forecast is too low, negative errors when the
forecast is too high.

o Forecast errors influence decisions in two somewhat different ways.

o One is making a choice between various alternatives;

o Evaluating the success or failure of a technique in use

APPROACHES TO FORECASTING

There are two general approaches in forecasting: qualitative and quantitative.

 QUALITATIVE – methods is consist mainly of subjective inputs, which is often

defy precise numerical description.

 QUANTITATIVE – methods involves either the projection of historical data or the

development of associate models that attempt to utilize casual (explanatory)

variables to make a forecast.

The following pages present a variety of forecasting techniques that are

classified as judgmental, time-series or associative.

- Judgmental forecast – this are forecast that use subjective inputs such as

opinion from consumer surveys, sales staff, managers, executives, and experts.

 Executive opinions – a small group of upper-level managers may meet

and collectively develop a forecast. This approach is often used as a part

of long-range planning and new product development.

 Sales force 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 customer

may be considering for the future.

 Consumer surveys – because it is the consumers who ultimately

determine demand, it seems natural to solicit input from them. In some

instances, every customer or potential customer can be contacted.

 Delphi method – It is an iterative process intended to achieve a

consensus forecast. This method involves circulating a series of

to contribute meaningfully.

- Time-series forecast – forecast that project patterns identified in recent time-

series observations.

 Trend – refers to a long-term upward or downward movement in the data.

 Seasonality – refers to short-term, fairly regular variations generally

related to factors such as the calendar or time of the day.

 Cycles – are wavelike variations of more than one year’s duration.

 Irregular variation – are due to unusual circumstances such as severe

weather conditions, strikes, or a major change in a product or service.

 Random variations – are residual variations that remain after all other

behaviors have been accounted for.

- Associative model – forecasting technique that uses explanatory variables to

predict future demand.