CHAPTER TWO

MATERIAL DEMAND FORECASTING

2.1. Meaning, Characteristics and uses of Forecasting
Forecasts are estimates of the occurrence, timing or magnitude of future event. They give
operation managers a rational basis for budgeting, capacity planning, sales production and
inventory, personnel and material management. Forecasting is the basis of planning ahead even
though the actual demand is quite uncertain. Planning involves estimation of the future, and of
particular interest here is the expected demand of company’s product. Therefore, forecast of
future demand is the link between company’s internal expectations with outside environment that
permits planning function to commence activities. Forecast affects decisions and activities
throughout the organization in finance, HRM, marketing, operations and other functions.

Characteristics of forecasts

The following are the characteristics of forecasts:-

1. Forecasting techniques generally assumes that the same underling causal system that
assisted in the past will continue to exist in the future.
2. Forecasts are rarely perfect; actual results usually differ from predicted values.
3. Forecasts for a group of items tends to be more accurate than forecasts for individual
item, because forecasting errors among items in a group usually are smaller than that of
individual items.
4. Forecast accuracy decreases as the time period covered by the forecast-time horizon
increases.
Uses of Forecast
Forecast should be used for end items and services that have uncertain demand. The purpose of
forecasting activities is to make the best use of present information to guide decisions towards
the objectives of the organization in general. Accurate projections of future activity levels can
minimize short-term fluctuations in production and help balance workloads. This reduces hiring,
firing and overtime activities and helps maintain good labor relationship.
Good forecasts also help managers have appropriate level of materials available when needed.
By anticipating employment and materials needs, the forecasts enable managers to make better
use of facilities and give improved service to customers.
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 Generally, good forecast
- could improve employee relation
- improve materials management
- helps to have better use of capital and facilities and
- Improves customers’ service.

BASIC APPROACH TO DEMAND FORECASTING

There are five basic steps in the forecasting process

1. Determine the purpose of the forecast and when it will be needed
2. Establish the time horizon that the forecast must cover
3. Select a forecast technique
4. Gather and analyze the appropriate data and then prepare the forecast
5. Monitor the forecast to see if it is performing in a satisfactory manner, if it is not,
reexamine the method
2.2. Techniques of forecasting

There are two types of forecasting technique. They are:

1. Qualitative forecasting techniques
2. Quantitative forecasting techniques

2.2.1 Qualitative forecasting techniques

Qualitative forecasting technique is a technique that is used when there is no historical data
available about past performance. These forecasting techniques are subjective and judgmental in
nature and most of the time they are based on opinion and expertise judgment. Qualitative
forecasting techniques rely on analysis of subjective inputs obtained from customers, sales
Person, managers and experts. There are four common types of qualitative forecasting
techniques. They are:
1. Expert opinion method
2. Sales opinion
3. Consumer surveys
4. Delphi technique
1. Expert Opinion methods

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One of the most simple and widely used method of forecasting which consists of collecting
opinions and judgments of individuals who are expected to have the best knowledge of current
activities or future plans. This technique has its own advantages and disadvantage.
Advantage
- Decision is fast
- Responsibility and accountability is clear
- Brings together the considerable knowledge, experience, skill and talent of various
managers
- Managers (experts) will acquire experience that is obtained in the discussion.
Disadvantage
- Probably poor forecast (due to lack of experience)
- Domination by one or few manger
- Diffusing responsibility for the forecast over the entire group may result in less
pressure to produce a good forecast.
2. Sales force Opinions
In this method, the sales representatives are required to estimate the demand for each product and
the forecast of each sales representative is consolidated to prepare the overall forecast for the
company. This forecasting technique has also its own advantages and disadvantages
Advantages
- It can reset in quality forecast
- This pools together knowledge
Disadvantage
- Time taking decision
- Influenced by majority high stares persons
- Avoidance of responsibility
3. Consumer Surveys
This forecasting technique is based on the data which is collected from the consumers. Because it
is the consumers who ultimately determine demand, it seems important to solicit information
from them.
Advantage
- Enhance the quality and accuracy of forecasts

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Disadvantage
- Experience and knowledge is constructing
- Expensive and time consuming
4. Delphi Method
This is a qualitative method of forecasting which involves the development, distribution,
collection and analysis of series of questionnaires to get the views of expertise that are located at
different geographic areas to generate the forecast. A moderator compiles results and formulates
a new questionnaire that is again submitted to the same group of experts. The goal is to achieve a
consensus forecast.
Advantage
- The tendency of process loss is avoided/minimized
- No influence of the majority
Disadvantage
- It takes time to reach a consensus
- Coordination and interpretation difficulty.
2.2.2 Quantitative forecasting techniques
There are two types of quantitative forecasting techniques:
1. Time series analysis
2. causal methods
1. Time Series analysis
A time series is a set of some variable (demand) overtime (e.g. hourly, daily, weekly, quarterly
annually). Time series analyses are based on time and do not take specific account of outside or
related factors. Forecasting techniques based on time series data are made on the assumption that
history follows a pattern that will continue. Time series analysis is a time-ordered series of
values of some variables. The value in any specific time period is a function of four factors:
a) Trend c) Cycles
b) Seasonality d) Randomness
a) Trend – is a general pattern of change overtime. It represents a long time secular
movement, characteristic of many economic series.
Seasonality- refers to any regular pattern recurring with in a time period of no more than
one year. These effects are often related to seasons of the year.

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 - Seasonality is regularly repeating upward or down ward movements in series value
that can be tied to recurring events.
Example:
- Weather variations – sales of winter and summer
- Vacations or holidays – airline travel, greeting card, visitors at tourists
Seasonality in time series is expressed in terms of the amount that actual sales deviate from the
average value of a series.
c) Cycle – are long-term swings about the trend line and are usually associated with a business
cycle (phases of growth and decline in a business cycle).
d) Randomness – are sporadic effects due to chance and unusually occurrences.
Types of time series analysis:- The different types of time series analysis.
A. Naive Approach
Assumes demand in next period is the same as demand in most recent period
 E.g. if the actual demand of umbrella is 60 units on Monday, the forecasted demand for
Tuesday will be 60 units.
B. Simple Moving average
A simple moving average is obtained by summing and averaging values from a given number of
periods repetitively, each time deleting the oldest value and adding the new value.
A t−1 + At−2 + A t−3 +.. .+ At−n
SMA = Ft = n
n
∑ A t −i
i=1
=
Where
SMA – simple moving average
Ft - Forecast for period t

At-i - Actual demand in period t-i

n - Number of periods (data points) in the moving average
Simple moving average is preferable if the demand for a product is neither growing nor declining
rapidly and also does not have any seasonal characteristics.
Example 1:

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A food processor uses a moving average to forecast next month’s demand. Past actual demand
(in units) is shown in the following table

Month 1 2 3 4 5 6 7 8
Actual demand 105 106 110 11 114 121 130 128
0
Required
a) compute a simple 5 month moving average to forecast demand for month 9
b) Find a simple 5 month moving average to forecast the demand for month 10 if the actual
demand for month 9 is 123.
Solution
128+130+121+114 +110
a) SMA9 = F9 = 5
= 120.6
Therefore, the forecasted demand for month 9 is 120.6.
123+128+130+ 121+ 114
b) SMA10 = F10 = 5
= 616/5 = 123.2
Therefore, the 5 month moving average forecasted demand for month 10 is 123.2.
Note: In moving average, as each new actual value becomes available, the forecast is updated by
adding the newest value and dropping the oldest value and computing the average.
The advantages and disadvantages of this technique are:-
Advantage
- easy of computation
- easy of understanding
Disadvantage
- All values in the average are weighted equally. The oldest value has the same weight
as the most recent value.
Example 2:
Sunrise Bakery makes cakes and supply to the market. The following data shows their daily
demand for the last four weeks. The bakery is closed on Saturday. So Friday’s production must
satisfy demand for both Saturday and Sunday.

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 4 weeks 3 weeks 2 weeks Last week
ago ago ago
Monday 200 400 300 400
Tuesday 200 100 100 300
Wednesday 300 400 300 500
Thursday 800 900 400 100
Friday 500 200 300 400
Saturday 800 700 600 500
Sunday
Total 2800 2700 2000 2200

Required: Make forecast for this week on the following basis.

a) Daily, using a simple four week moving average?
b) Daily, using a simple three week moving average
c) Weekly, using a simple four week moving average
d) Weekly, using a simple three week moving average
Solution
a) Simple four-week moving average
400 +300+400+ 200
=325
Monday, Fmonday = 4
300+100+100+ 200
=175
Tuesday Ftuesday = 4
Wednesday, Fwednesday = 1500/4 = 375
Thursday, Fthursday = 2200/4 = 550
Friday, Ffriday =1400/4 = 350
Sat. & Sunday, FSat & Sunday = 2600/4 = 650
b) Simple three week moving average
400 +300+400 1100
= =367
Monday, Fmonday = 3 3
300+100+100 500
= =167
Tuesday Ftuesday = 3 3

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 Wednesday, Fwednesday = 1200/3 = 400
Thursday, Fthursday = 1400/3 = 467
Friday, Ffriday = 900/3 = 300
Sat. & Sunday, FSat & Sunday = 1800/3 = 600

2800+2700+ 2000+2000+2200
= 2425
c) Fnext week = 4
2800+2000+ 2000
= 2300
d) Fnext week = 3
C. Weighted Moving average
In weighted moving average, the weight is given in such a way that more weight is given to the
most recent value in the time series. Weights can be percentages or any real numbers.
In weighted moving average, forecasts are calculated by
Ft = WMA = W1At-1+W2.At-2+… +Wn.At-n
n
∑ A t−1 . W i
= i=1
Where
Ft =forecast in time t
WMA = weighted moving average
W = weight
A = Actual demand value
Example 1
A department store may find that in a four month period the best forecast is derived by using
40% of the actual demand for the most recent month, 30% two months ago, 20% of three months
ago and 10% of our months ago. The actual demands were as follows.
Month Month 1 Month 2 Month 3 Month 4
Demand 100 90 105 95

Required:
a) Compute weighted 4-month MA for month 5
WMA = 95x0.4+105x0.3+90x0.2+100x0.10

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 = 97.5 units
b) Suppose the demand for month 5 actually turned out to be 100. Compute forecast for month 6.
F6 =WMA = 0.4x110+0.30x95+0.2x105+0.1x90
F6 = 102.5 units.
Example 2
See example 2 above in simple moving average
Required:
a) Make a daily basis forecast for this week using a weighted average of 0.40 for last week,
0.30 for two weeks ago, 0.20 for three weeks ago and 0.10 for four weeks ago?
Solution
a) 40% of last 30% of 2 weeks 20% of 3 weeks 4 weeks ago Total
week (0.40) ago (0.30) ago (0.20) (0.10)

Monday 160 90 80 20 350

Tuesday 120 30 20 20 190
Wednesda 200 90 80 30 400
y
Thursday 40 120 180 80 420
Friday 160 90 40 50 340
Saturday
200 180 140 80 600
Sunday

D. Simple exponential smoothing

The other type of time series forecasting method is simple exponential smoothing which weights
past data in an exponential manner so that most recent data carry more weight in the moving
average. With simple exponential smoothing, the forecast is made up of the last period forecast
plus a portion of the difference between the last period actual demand and the last period actual
demand and the last period forecast.
Mathematically
Ft = F t-1 + (A t-1 - F t-1)
Where

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 Ft = Forecast for period t
Ft-1 = Forecast for the previous period
 = Smoothing constant (0<  <1)
A t-1 = Actual demand for the previous period
The difference between the actual demand and the previous forecast (i.e. A t-1 – Ft-1) represents
the forecast error. If actual demand was above the last period forecast, the correction will be
positive, and if the actual demand was below the last period forecast, the correction will be
negative. The smoothing constant, actually dictates how much corrections will be made. It is a
number between 0 and 1, and it is used to compute the forecast Ft.
Exponential smoothing is the most widely used of all forecasting techniques, because
a. Exponential forecasting models provide closer forecasts to actual demand.
b. Formulating an exponential smoothing model is relatively easy.
c. The user can easily understand the model
d. It requires little computation
e. It requires only three pieces of data
- The most recent forecast
- The actual demand of the previous period
- The smoothing constant, 
Example 1:
The production supervisor at a fiber board plant uses a simple exponential smoothing technique
( = 0.2) to forecast demand. In April, the forecast was for 20 shipments, and the actual demand
was for 20 shipments. The actual in May and June was 25 and 26 shipments. Forecast value for
July.
Solution
First forecast the demand for may and June
Fmay = FApril +  ( A April –F April)
= 20+0.2(20-20) = 20
FJune = FMay +  (AMay –FMay)
= 20+0.2(25-20)
= 21
FJuly = FJune +  ( AJune –FJune)

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 = 21+0.2(26-21)
= 22
Example 2: Demand during the past six months have been as follows:
January 115
February 123
March 132
April 134
May 140
June 147
Required:
Using simple exponential smoothing with  = 0.70, if the forecast for January had been 110,
compute the exponentially smoothed forecasts for each month through July.
Solution:
FFeb. = FJan. +  ( AJan. –FJan.)
= 110+0.7(115-110)
= 113.5
FMarch. = FFeb.. +  (AFeb.. – FFeb.)
= 113.5+0.7(123-113.5)
= 120.15
FApril. = FMarch. +  (AMarch. –FJan)
= 120.15+0.7(132-120.15)
= 128.445
FMay = FApril. +  (AApril. –FApril)
= 128.445+0.7(134-128.445)
= 132.33
FJune. = FMay. +  (AMay –Fmay.)
= 132.33+0.7(140-132.33)
= 138

Trend equation
A linear trend equation has the form

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 Ft = at + b
Where Ft = forecast for period t
a = scope of the line
b = value of Ft , at t = 0
t = specified number of time periods from t = 0
The coefficients of the line, a and b can be computed from historical data using these two
equations.
n . ∑ ty−Σt . Σy
2 2
a = n. Σt −( Σt )
Σy−aΣt
b= n
Example:
Monthly demand for Wonji sugar factory over the past six months for sugar is given below
Month (in ‘000 tones) Sept. Oct Nov. Dec. Jan. Feb.
Actual demand 112 125 120 133 136 140

Required:
a) Obtain the trend equation?
b) Forecast the demand for the next two months?
Solution
First lets find the values of the coefficients a and b.
n . Σ ty−Σt . Σy Σy−aΣt
2 2
a= n . Σt −( Σt ) , b= n
t t2 y ty
1 1 112 112
2 4 125 250
3 9 120 360
4 16 133 532
5 25 136 680
6 36 140 840
=21 91 766 2554

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 Now let’s compute a, and b
n . Σ ty−Σt . Σy 6 x 2774−21 x 766
2 2 2
a= n . Σt −( Σt ) = 6 x 91−(21) = 5.314
Σy−aΣt 766−5. 31 x 21
b= n = 6 = 109
a) The trend equation
Ft = Y = at + b
= 5.31t + 109
b) Forecast for the next two months (i.e. March and April)
Fmarch = F7 = 5.31(7) + 109
= 146,000 tones
FApril = F8 = 5.31 x 8 + 109
= 153,000 tones
2. Casual forecasting methods
Casual forecasting techniques rely on identification of related variables that can be used to
predict values of the variable of interest (demand). Casual methods are used when historical data
are available and the relationship between the factor to be forecasted.
Example
 Crop yield are related to
 Soil conditions
 Amounts and timings of water
 Fertilizer application
Regression and Correlation Methods
Regression and correlation techniques are means of describing the association between two or
more variables.
More specifically, regression and correlation methods are related to the following issues
i. Bringing out the nature of relationship between any two variables, say X and Y
ii. Measuring the rate of change in one (the dependent) variable associated with a given
change in the other (independent) variable.
iii. Evaluating the strength of the relationship and quantifying the closeness of such
relationship.

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Regression
It is concerned about the first two issues, i.e.
- Bringing out the nature of relationship between any two variables.
- Measuring the rate of change in one (the dependent) variable associated with a given
change in the other (independent) variable.
 Regression means ‘dependence’ and involves estimating the value of a dependent
variable, Y, from an independent variable X.
There are two types of regression
a. Simple regression
b. Multiple regression
In simple regression only one independent variable is used, and the general form of this simple
regression is Y = b + ax. Where as in multiple regression two or more independent variables are
involved, and multiple regressions take the general form of
Y = b + ax1 Cx2 + dx3 + … + Zxn
Correlation
Correlation is concerned about evaluating the strength of the relationship and quantifying the
closeness of such relationship.
Simple Linear regression and correlation
In simple linear regression, only one independent variable is used and the model takes the form
Y = a + bx
Where
Y = predicted (dependent) variable, demand
a = value of Y at X = 0
b = slope of the line
Note: It is convenient to represent the values of the predicted variable on the Y-axis and values
of the predictor variable on the X-axis.

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