Operation Management- Module 1 (THE PRODUCTION

AND OPERATIONS FUNCTION)

Business Administration (Tarlac State University)

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THE PRODUCTION AND OPERATIONS
FUNCTION 5. Inputs to the process
One set of inputs to any operation’s processes
1. What is the definition of production? are transformed resources. These are the
The processes and methods used to transform resources that are treated, transformed or
tangible inputs (raw materials, semi-finished converted in the process. They are usually a
goods, subassemblies) and intangible inputs mixture of the following:
(ideas, information, knowledge) into goods or Materials – operations which process
services. Resources are used in this process to materials could do so to transform their physical
create an output that is suitable for use or has properties (shape or composition, for example).
exchange value. Most manufacturing operations are like this.
Other operations process materials to change
2. What is the definition of Operations their location (parcel delivery companies, for
Management? example). Some, like retail operations, do so to
Operations management is the activity of change the possession of the materials. Finally,
managing the resources which are devoted to the some operations store materials, such as
creation and delivery of services and products. It warehouses.
is one of the core functions of any business, Information – operations which process
although it may not be called operations information could do so to transform their
management in some industries. informational properties (that is the purpose or
Operations management is concerned with form of the information); accountants do this.
managing processes. And all processes have Some change the possession of the information,
internal customers and suppliers. But all for example market research companies sell
management functions also have processes. information. Some store the information, for
Therefore, operations management has example archives and libraries. Finally, some
relevance for all managers. operations, such as telecommunication
companies, change the location of the
3. Why is operations management important in information.
all types of organization? Customers – operations which process
Operations management uses the organization’s customers might change their physical
resources to create outputs those fulfil defined properties in a similar way to materials
market requirements. This is the fundamental processors: for example, hairdressers or
activity of any type of enterprise. cosmetic surgeons. Some store (or more politely
Operations management is increasingly accommodate) customers: hotels, for example.
important because today’s business environment Airlines, mass rapid transport systems and bus
requires new thinking from operations companies transform the location of their
managers. customers, while hospitals transform their
physiological state. Some are concerned with
4. The input – transformation – output process transforming their psychological state, for
All operations create and deliver services and example most entertainment services such as
products by changing inputs into outputs using music, theatre, television, radio and theme
an ‘input–transformation–output’ process. The parks. But customers are not always simple
table shows this general transformation process ‘passive’ items to be processed. They can also
model. Put simply, operations are processes that play a more active part in many operations and
take in a set of input resources which are used to processes. For example, they create the
transform something, or are transformed atmosphere in a restaurant; they provide the
themselves, into outputs of services and stimulating environment in learning groups in
products. And although all operations conform education; they provide information at check-in
to this general input–transformation–output desks, and so on. When customers play this role,
model, they differ in the nature of their specific it is usually referred to as co-production (or co-
inputs and outputs. creation for new services) because the customer
plays a vital part in the provision of the
product/service offering.

The following table gives examples of

operations with their dominant transformed
resources.

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6. Outputs from the process
Products and services are different. Products are 9. What do operations managers do?
usually tangible things, whereas services are So, you are considering a career in operations
activities or processes. A car or a newspaper or management, and you want to know, ‘is it for
a restaurant meal is a product, whereas a service you?’ What skills and personal qualities will
is the activity of the customer using or you need to make a success of the job as well as
consuming that product. Some services do not enjoying yourself as you progress in the
involve products. Consultancy advice or a profession? Well, the first thing to recognize is
haircut is a process (though some products may that there are many different roles encompassed
be supplied in support of the service, such as a within the general category of ‘operations
report or a hair gel). Also, while most products management’. Someone who makes a great risk
can be stored, at least for a short time, service control system designer in an investment bank
only happens when it is consumed or used. So, may not thrive as a site manager in a copper
accommodation in a hotel room, for example, mine. A video game project manager has a
will perish if it is not sold that night; a restaurant different set of day-today tasks when compared
table will remain empty unless someone uses it with a purchasing manager for a hospital. So,
that evening. the first skill you need is to understand the range
of operations-related responsibilities that exist in
7. Value of Customers various industries. However, there are also some
Customers may be an input to many operations, generic skills that an effective operations
but they are also the reason for their existence. manager must possess. Here are some of them.
If there were no customers (whether business
customers, users or consumers), there would be • Enjoys getting things done – operations
no operation. So, it is critical that operations management is about doing things. It
managers are aware of customer needs, both takes energy and/or commitment to
current and potential. This information will finishing tasks. It means hitting
determine what the operation has to do and how deadlines and not letting down
it has to do it (the operation’s strategic customers, whether they are internal or
performance objectives), which in turn defines external.
the service/product offering to be designed, • Understands customer needs –
created and delivered. operations management is about adding
value for customers. This means fully
8. Model of Operations Management understanding what ‘value’ means for
The first is the idea that operation and the customers. It means putting yourself in
processes that make up both the operations and the customer’s place: knowing what it is
other business functions are transformation like to be the customer and knowing how
systems that take in inputs and use process to ensure that your services or products
resources to transform them into outputs. The make the customer’s life better.
second idea is that the resources both in an • Communicates and motivates –
organization’s operations as a whole and in its operations management is about
individual processes need to be managed in directing resources to produce services
terms of how they are directed, how they are or products in an efficient and effective
designed, how delivery is planned and manner. This means articulating what is
controlled and how they are developed and required and persuading people to do it.
improved. The Table shows how these two Interpersonal skills are vital. Operations
ideas go together. This module will use this managers must be ‘people-people’.
model to examine the more important decisions • Learns all the time – every time an
that should be of interest to all managers of operations manager initiates an action
operations and processes. (of any kind) there is an opportunity to
learn from the result. Operations
management is about learning, because
without learning there can be no

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 improvement, and improvement is an through the total operation to customers
imperative for all operations. must be planned and controlled
• Committed to innovation – operations • Developing process performance.
management is always seeking to do Increasingly it is recognized that
things better. This means creating new operations managers, or indeed any
ways of doing things, being creative, process managers, cannot simply
imaginative, and (sometimes) routinely deliver services and products in
unconventional. the same way that they always have done.
• Knows their contribution – operations They have a responsibility to develop the
management may be the central function capabilities of their processes to improve
in any organization, but it is not the only process performance
one. It is important that operations
managers know how they can contribute 10. Operations managers and some
to the effective working of other responsibilities
functions. So, operations managers are responsible for
• Capable of analysis – operations managing activities that are part of the production
management is about making decisions. of goods and services. Their direct responsibilities
Each decision needs to be evaluated include managing both the operations process,
(sometimes with very little time). This embracing design, planning, control, performance
involves looking at both the quantitative improvement, and operations strategy. Their
and the qualitative aspects of the indirect responsibilities include interacting with
decision. Operations managers do not those managers in other functional areas within the
necessarily have to be mathematical organization whose roles have an impact on
geniuses, but they should not be afraid of operations. Such areas include marketing, finance,
numbers! accounting, personnel and engineering.
• Keeps cool under pressure – operations
managers often work in pressured Operations managers' responsibilities include:
situations. They need to be able to • Human resource management – the people
remain calm no matter what problems employed by an organization either work
occur. directly to create a good or service or
provide support to those who do. People and
The exact details of what operations managers the way they are managed are a key resource
do will, to some extent, depend on the way an of all organizations.
organization defines the boundaries of the
• Asset management – an organization's
function. Yet there are some general classes of
buildings, facilities, equipment and stock are
activities that apply to all types of operation
directly involved in or support the
irrespective of whether they are service,
operations function.
manufacturing, private or public sector, and no
matter how the operations function is defined. • Cost management – most of the costs of
We classify operations management activities producing goods or services are directly
under four headings: direct, design, deliver and related to the costs of acquiring resources,
develop. transforming them or delivering them to
customers. For many organizations in the
• Directing the overall nature and private sector, driving down costs through
strategy of the operation. A general efficient operations management gives them
understanding of operations and a critical competitive edge. For
processes and their strategic purpose and organizations in the not-for-profit sector, the
performance, together with an ability to manage costs is no less important.
appreciation of how strategic purpose is Decision making is a central role of all
translated into reality, is a prerequisite to operations managers. Decisions need to be
the detailed design of operations and made in:
process
• Designing the operation’s services, • designing the operations system
products and processes. Design is the • managing the operations system
activity of determining the physical form,
shape and composition of operations and • improving the operations system.
processes together with the services and The five main kinds of decision in each of
products that they create these relate to:
• Planning and control process delivery.
1. the processes by which goods and services
After being designed, the delivery of
are produced
services and products from suppliers and
2. the quality of goods or services

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 3. the quantity of goods or services (the Apart from the technical aspects of the job, they
capacity of operations) are also required to manage their teams by
4. the stock of materials (inventory) needed to addressing concerns and complaints. Moreover,
produce goods or services they also assist in interviewing, hiring, and
training new employees, along with regular
5. the management of human resources. performance reviews, appraisals, and
promotions.
11. Careers in Operations Management
The concept of operations management has been Associate Product Manager
around for a very long time; however, there is An associate product manager participates in the
an increasing number of aspirants who today creation of new products and features right from
specialize in MBA in Operations Management ideation to launch. Their prime responsibility
due to the numerous opportunities available in includes gathering product requirements and
the job market today. Contemporary operations suggesting product enhancements to improve
are inclusive of strategic elements with user experience. They are also required to be
behavioral and engineering concepts. Operations familiar with market research and competitor
utilize management science, operations research analysis to identify market needs accurately.
tools and techniques for systematic decision- They also need to monitor and report consumer
making and problem-solving thus interacting reactions after a product is launched.
with other functional areas within the
To be successful in this job role, it's vital that an
organization.
associate product manager communicate and
Earlier Operations was recognized as a cost collaborate with other teams to understand
control exercise but the contemporary viewpoint customer and market requirements. Moreover,
for judging operations is changing from a it's also vital that they possess strong analytical
narrowly defined operating objective of cost and quantitative skills and can effectively use
control to global performance measurements in data and metrics to provide recommendations
areas such as product performance and variety, and make the right decisions.
product quality, delivery time, customer service,
Operations Manager
and operational flexibility. By linking
Operations managers have varied
operations and operating strategies with the
responsibilities and are, therefore, a senior
overall strategy of the organization, be it
position. The duties vary based on the company
engineering, financial, marketing or information
and the product or service they offer. However,
system strategies better synergies are extracted.
there are a few responsibilities that are universal
The widened scope of operations management
across industries.
has led to a rise in job opportunities for those
looking for a break into this sector. An operations manager is liable for identifying
operational inputs, processes, outputs, and
Operations management is essential for all
feedback. With the information they gather, they
industries like banking, hospitals, e-commerce,
are also accountable for transforming processes
suppliers, manufacturers, technology
to improve operational systems and policies to
companies, and more. While the core aspects of
support the organization's target.
the job remain the same, there are a few refined
job roles that have been created based on the They also work closely with the Chief of
industry. Let's take a look at some of these job Operations (COO) and oversee financial
roles: management, planning, systems, and controls.
Their aim in doing so is to measure and manage
Deputy Manager Manufacturing
the impact that working capital, budgets,
A deputy manager manufacturing is responsible
financial statements, and cost-cutting has on the
for planning, managing, and executing
overall cash flow of a business.
manufacturing operations. They are also
accountable for ensuring the execution of the Finally, they are also accountable for enhancing
manufacturing process is prioritized in the effectiveness and productivity of the HR, IT,
accordance with the process workflow and and finance departments and implement reforms
schedule. to each department if required. Their goal is to
build an empowering work atmosphere to
Since deputy manufacturing managers are
maximize and align workforce efforts and
responsible for the production process, they are
overall team productivity.
also required to inspect production equipment to
prevent any malfunctions regularly. If they do Supply Chain Functional Analyst
identify any issues, they are required to report The primary duty of a supply chain functional
the operational or maintenance problems to analyst is to deliver projects in the supply chain
avoid delays in production.

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division by focusing on planning, fulfillment, Functional Consultant
manufacturing, sourcing, & procurement. A A functional consultant may be assigned
supply chain functional analyst does this by responsibility for specific functional vertical or
leveraging Supply Chain Packaged Solutions in client-specific tasks. Given the complexity, it
improving the client's business performance. requires the delivery of specific capability in
Many supply chain functional analysts are Technology Consulting. A functional consultant
required to have an understanding of tools like needs to understand Business Requirements and
SAP, Oracle, JDA, Kinaxis, etc. Needs and accordingly support application
design, develop functional/process documents,
They collect data to help improve an Build, test and deliver solutions. A functional
organization's supply chain operations and consultant is responsible for Functional
report to department heads. They also identify specification creation, functional Unit Testing,
problems with the workflow, analyze costs and Test Data Creation & Test scripts creation and
benefits, suggest improvements, and assist in execution. A functional consultant has to adhere
negotiations with suppliers. Moreover, they are to defined processes and tools while performing
also required to understand client requirements day-to-day operations
and translate them into business and technology
solutions. Analyst Operations Advisory Services
Analyst Operations Advisory Services is
Sourcing Specialist expected to support in building and executing
Sourcing Specialist’s task is to develop both innovative solutions for delivery excellence at
short- and long-term sourcing plans by an optimized delivery cost. Business operations
benchmarking all suppliers, contracts, and analysts are in charge of conducting extensive,
services associated with delivering services. accurate analyses of their organization's existing
Provide evaluations of suppliers’ (product and business operations. Their main duties include
services) capabilities and how they relate in the gathering data and developing solutions to meet
competitive landscape. The sourcing specialist business needs. They also analyze cross-
has to lead supplier development and sourcing departmental business processes for efficiency.
activities in supplier selection and qualification
for assigned products & services. One has to There are various specificity roles that fall under
continuously drive supplier productivity, quality the category of operations management, and all
and services to improve supplier performance of them are integral to an organization's success.
and meet business operation targets. While there is pressure to get the job done right,
there is also an immense opportunity for career
The Sourcing Specialist is also expected to growth. Operations management professionals
gather information on the market trends and can grow to hold the position of Chief of
current market price points, create information Operations with enough experience.
repository & share the latest insights with the
management, use the market benchmarks of There are various other professions available as
other large organizations in order to improve well, like, Logistics Manager, Warehouse
current price points in the vendor ecosystem. Manager, Asst. Management -Quality, Vendor
Conducting periodic market benchmarks and Development, Category Manager, etc.
comparison of suppliers is an ongoing activity
with this role. FORECASTING

Supplier Risk Manager 1. What is Demand Management?

Supplier Risk Manager is expected to conduct a Demand Management is gauging the demand
supplier risk assessment for Operational risk, for a product or service in the future
Information security risk and reputational risk and planning the manufacturing so there
for a supplier before on-boarding. Maintain wouldn’t be supply and demand gaps.
supplier compliance in terms of local
regulations and company policies/processes. The success of any business depends upon how
Partner with stakeholders to identify they are creating the demand for a product in
opportunities within the Organization for new the target market and then, how they are
initiatives, support the sourcing team to execute managing the supplies to fulfill that demand.
special & simplification projects based on It is the process of prediction and the planning
stakeholder requirements to meet Quality of demand, which comes regarding a particular
standards & timelines. Gather information on product.
the market trends and current market price
points, create information repository & share the 2. What is Demand Management Process?
latest insights with the management, use the Demand management is the supply chain
market benchmarks of other large organizations management process that balances the
in order to improve current price points customers' requirements with the capabilities of

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 the supply chain. With the right process in
place, management can match supply with • Sales and Operations Planning - For
demand proactively and execute the plan with effective Demand Management, it is
minimal disruptions. The process is not limited essential that you pay attention to the
to forecasting. It includes synchronizing supply roles, operations, and importance of all the
and demand, increasing flexibility, and reducing stakeholders in the supply chain system.
variability. In this paper, we describe the Based on these reports, you can do effective
demand management process in detail to show Sales and Operations Planning to manage
how it can be implemented within a company the demand requirements.
and managed across firms in the supply chain.
We examine the activities of each sub-process; 5. What is Forecasting?
evaluate the interfaces with corporate functions, Forecasting is the process of making predictions
processes and firms; and provide examples of of the future based on past and present data and
successful implementation. most commonly by analysis of trends. A
commonplace example might be estimation of
3. What are the demand management some variable of interest at some specified
techniques? future date. Prediction is a similar, but more
The three, master production scheduling (MPS) general term. Both might refer to formal
environments of make-to-stock (MTS), statistical methods employing time series, cross-
assemble-to-order (ATO), and make-to-order sectional or longitudinal data, or alternatively to
(MTO) utilize different demand management less formal judgmental methods. Usage can
techniques. In MTS production, highly detailed, differ between areas of application: for example,
item level forecasts are required, by location and in hydrology the terms "forecast" and
time period. The difficulty of forecasting "forecasting" are sometimes reserved for
individual items can be dealt with by using estimates of values at certain
ratios or percentages of aggregated forecasts as specific future times, while the term
a surrogate for the individual units. This is "prediction" is used for more general estimates,
appropriate in firms with steady product mix such as the number of times floods will occur
ratios and allows management to devote time to over a long period.
forecasting overall sales. In the ATO
environment, the key issue is accurate order In preparing plans for the future, the
promise dates, which calls for a stable MPS. management authority has to make some
This is achieved by using time fencing and predictions about what is likely to happen in the
related methods. In MTO environments, control future.
of customer orders in the production system is
important. Usually, there is much uncertainty It shows that the managers know something of
concerning future orders, which may require future happenings even before things actually
extensive new design and engineering. happen.
Forecasting provides them this knowledge.
4. What are the components of Demand Forecasting is the process of estimating the
Management? relevant events of future, based on the analysis
• Forecasting - In this, a business will of their past and present behavior.
forecast the future demands of a particular
product or service that they The future cannot be probed unless one knows
offer. Forecasting is done as per the current how the events have occurred in the past and
trend, projected sales, and analytical data of how they are occurring presently. The past and
customer behavior. It also helps businesses present analysis of events provides the base
in preparing for any unexpected events in helpful for collecting information about their
the future. future occurrence.
Thus, forecasting may be defined as the process
• Supply Planning - Businesses need to be
of assessing the future normally using
prepared for the future requirements of the
calculations and projections that take account of
supplies. Being well aware of the
the past performance, current trends, and
requirements of customers, competitors’
anticipated changes in the foreseeable period
influence and market trends help businesses
ahead.
in doing efficient supply planning.
Forecasting provides a logical basis for
• Demand Analysis - It is important that your determining in advance the nature of future
demand forecasting is based upon the business operations and the basis for managerial
current sales data. Proper analysis of order decisions about the material, personnel and
history will help you do the right demand other requirements.
analysis for effective Demand Management.

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 It is, thus, the basis of planning, when a business 7. Approaches to Forecasting
enterprise makes an attempt to look into the
future in a systematic and concentrated way, it A. Top-down Approach:
may discover certain aspects of its operations In this approach, forecast is done at the
requiring special attention. However, it must be corporate level or the strategic level. It
recognized that the process of forecasting starts with a forecast of general economic
involves an element of guesswork and the conditions. It forecasts gross national
managers cannot stay satisfied and relaxed after product, consumer and wholesale price
having prepared a forecast. index, interest rates, unemployment level,
The forecast will have to be constantly government expenditures, etc. and
monitored and revised—particularly when it estimates the market potential of the
relates to a long- term period. The managers product for the entire industry.
should try to reduce the element of guesswork in
preparing forecasts by collecting the relevant Then, it determines its current market
data using the scientific techniques of analysis share and forecasts success of its product
and inference. in the market. This forecast is used for
operational planning and budgeting the
Forecasting is a useful tool for planning. For future programmes.
instance, in sales planning, it helps to estimate
and forecast market share of a firm. Firms may B. Bottom-up Approach:
find it difficult to project sales of their product. In this approach, middle and lower-level
Identifying future sales problems is not easy for employees project the business operations
companies, small or big. in the coming years. For instance, they do
In some cases, it is very difficult to get customer survey to know what customers
information about future market sales. Sales want to buy. Such forecasts are made by
forecasting, in such a case, is not just an different sales people which are finally
estimation of sales; it is also matching sales summed up to give the sales forecast.
opportunities – actual and potential – with sales
planning and procedures. Usually a questionnaire is mailed or
completed through telephonic interview
with the prospective customers to make
such forecasts. These forecasts are usually
reliable for small period of one year.

8. Benefits of forecasting

6. A forecast requires assessment of two sets A. Future Oriented

of factors:
It enables managers to visualize and
(a) The outside forces which influence business discount future to the present. It, thus,
operations, such as the weather, government improves the quality of planning. Planning is
activity and competitive behavior. These forces done for future under certain known
are uncontrollable; conditions and forecasting helps in knowing
these conditions. It provides knowledge of
(b) The internal marketing methods or practices planning premises with which managers can
of the firm that are likely to affect its operations, analyze their strengths and weaknesses and
such as product quality, price, advertising, take action to meet the requirements of the
distribution and service. future market.

If forecast is a pre-requisite of planning, it is a For example, if the TV manufacturers feel

planning premise. For example, planning based that LCD or Plasma televisions will replace
on future economic conditions of the country is the traditional televisions, they should take
a planning premise. If forecast is made after the action to either change their product mix or
plans are put into action, it is not a planning start manufacturing LCD/Plasma screens.
premise. For example, a new machine is Forecasting, thus, helps in utilizing
purchased and put to use. Forecasts about resources in the best and most profitable
revenues from this machine is not a planning business areas.
premise but a mere forecast of the future
expectations. In the fast-changing technological world,
businesses may find it difficult to survive if

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 they do not forecast customers’ needs and manner. This helps to develop management
competitors’ moves. executives.

B. Identification of critical areas 9. Measures to Increase the effectiveness of

Forecasting helps in identifying areas that Forecasting:
need managerial attention. It saves the Forecasting provides information to facilitate
company from incurring losses because of decision-making and planning. In the complex and
bad planning or ill-defined objectives. By turbulent environment, forecasts may go wrong
identifying critical areas of management and and so would the plans based on these forecasts.
forecasting the requirement of different This may prove hazardous for the company but
resources like money, men, material etc., making plans not based on forecasts is more
managers can formulate better objectives hazardous.
and policies for the organization.
Forecasting, thus, increases organizational Forecasting is therefore, necessary. Since future
and managerial efficiency in terms of may not behave as predicted and deviations may
framing and implementing organizational occur, forecasting skills should improve to reduce
plans and policies. the range of errors. This amounts to making
forecasting effective.
C. Reduces Risk
Though forecasting cannot eliminate risk, it The following measures can help in increasing
reduces it substantially by estimating the the effectiveness of forecasting:
direction in which environmental factors are
moving. It helps the organization survive in A. Forecasting methods should be simple.
the uncertain environment by providing Complex methods can confuse data rather than
clues about what is going to happen in provide meaningful information.
future.
B. Compare forecasts with the situation of “no
If managers know in advance about changes change”. Changes may not always occur and
in consumer preferences, they will bring “no change” situation may prove to be accurate
required modifications in their product many times.
design in order to meet the changed
expectations of the consumers. Thus, C. Long range forecasts should not depend upon a
forecasting cannot stop the future changes single forecasting method. Several forecasting
from happening but it can prepare the methods should be adopted and average of their
organizations to face them when they occur results should be used to make predictions.
or avoid them, if they can.
D. Forecasts should not be made for very long
D. Coordination periods. Length of forecasts should be
Forecasting involves participation of shortened to improve their accuracy. Accuracy
organizational members of all departments of forecasts decreases as the time period of
at all levels. It helps in coordinating prediction increases.
departmental plans of the organization at all
levels. People in all departments at all levels E. Managerial skill should be improved to make
are actively involved in coordinating reliable forecasts for planning decisions.
business operations with likely future Whatever forecasts are made, they should have
changes predicted as a result of forecasting. complete support of the top management to
Thus, forecasting helps in movement of all make their implementation effective.
the plans in the same direction.
F. Forecasts should be based on facts and figures
E. Effective Management and not personal biases of the forecaster.
By identifying the critical areas of
functioning, managers can formulate sound
objectives and policies for their 10. Process of Forecasting
organizations. This increases organizational The following steps usually result in effective
efficiency, effectiveness in achieving the forecasting:
plans, better management and effective goal 1. Determine the objective for which forecast is
attainment. required:
Managers should know the reasons why forecasts
F. Development of Executives are required. If there are rapid changes in the
Forecasting develops the mental, conceptual environment, it is necessary to forecast the
and analytical abilities of executives to do environmental factors. Past records of the
things in planned, systematic and scientific companies provide useful framework to know how

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 effective forecasts have been in the past in making 3. Regulation of Forecasts:
business operations successful.
It has already been indicated that the managers
Unless managers are clear of the reasons why cannot take it easy after they have formulated a
forecasts are required to be made, the right choice business forecast. They have to constantly compare
of technique and also the right forecasts will not be the actual operations with the forecasts prepared in
made. Wrong forecasts lead to wrong business order to find out the reasons for any deviations from
decisions, faulty planning and losses for business forecasts. This helps in making more realistic
organizations. forecasts for future.

2. Select the appropriate forecast method: 4. Review of the Forecasting Process:

Depending upon the objective for which forecast is
required, managers select the appropriate Having determined the deviations of the actual
forecasting technique. These techniques may be performances from the positions forecast by the
quantitative or qualitative in nature. Based on past managers, it will be necessary to examine the
and present response of companies to environmental procedures adopted for the purpose so that
variables, these techniques represent future trend or improvements can be made in the method of
behavior of business activities. This future behavior forecasting
is supposed to be the likely outcome of forecasting
method adopted. 12. Techniques in Forecasting
There are a number of techniques through which
3. Compare the actual results: forecasts can be made. No technique can universally
Though managers put in the best of efforts to apply in similar business situations. These
forecast the future operations, the forecasts may still techniques, singly or in combination, are used
go wrong or the environmental changes may take depending upon the business situations when they
place other than those predicted. In either case, the have to be used.
results or outcomes of forecasts will be different
from those projected. The techniques of forecasting generally fall into
two categories:
This may require in making new forecasts or 1. Quantitative Forecasting
changes in plans because of changes in (Objective Approach)
environmental factors. The actual results are, thus, It applies mathematical models to past and
compared with the forecasted results and deviations present information to predict future outcomes.
are detected as soon as possible so that necessary These techniques are used to have access to hard
changes can be made in the forecasts or the plans. or quantifiable data. Some of the quantitative
techniques are time series analysis, regression
4. Review and revise the forecasts: models and econometric models.
If the actual results happen to be as projected, these
forecasts become the basis for future forecasting. If, 3. Qualitative Forecasting (Subjective
however, actual results are different from those Approach)
projected, the forecasts are reviewed and revised to It applies when data are not available or very
ensure better outcomes in the next forecasting little data are available. Managers use
period. judgement, intuition, knowledge and skill to
make effective forecasts. Some of the
11. Steps in Forecasting qualitative techniques are jury of executive
1. Developing the Basis: opinion method, sales force composite method
and users’ expectation method.
The future estimates of various business operations
will have to be based on the results obtainable 13. What are some methods of
through systematic investigation of the economy, Qualitative Forecasting?
products and industry. 1. Executive Committee Consensus
- Develop long to medium forecast by asking
2. Estimation of Future Operations: a group of knowledgeable executives their
opinions with regard to future values of the
On the basis of the data collected through items being forecasted.
systematic investigation into the economy and
industry situation, the manager has to prepare 2. Panel Approach
quantitative estimates of the future scale of business - Just as panels of football pundits gather to
operations. Here the managers will have to take into speculate about likely outcomes, so too do
account the planning premises. politicians, business leaders, stock market
analysts, banks and airlines. The panel acts
like a focus group, allowing everyone to talk
openly and freely. Although there is the

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 great advantage of several brains being 14. What are some methods of
better than one, it can be difficult to reach a Quantitative Forecasting?
consensus, or sometimes the views of the
loudest or highest status may emerge (the
bandwagon effect). Although more reliable 1. Time Series Model
than one person’s views, the panel approach Simple time series plot a variable over time
still has the weakness that everybody, even then, by removing underlying variations with
the experts, can get it wrong. assignable causes, use extrapolation techniques
to predict future behavior. The key weakness
3. Delphi method with this approach is that it simply looks at past
- Perhaps the best-known approach to behavior to predict the future, ignoring causal
generating forecasts using experts is the variables which are taken into account in other
Delphi method. This is a more formal methods such as causal modelling or qualitative
method which attempts to reduce the techniques. For example, suppose a company is
influences from procedures of face-to-face attempting to predict the future sales of a
meetings. It employs a questionnaire that is product. The past three years’ sales, quarter by
emailed or posted to the experts. The replies quarter, are shown in Figure S6.3(a). This series
are analyzed and summarized and returned, of past sales may be analyzed to indicate future
anonymously, to all the experts. The experts sales. For instance, underlying the series might
are then asked to reconsider their original be a linear upward trend in sales. If this is taken
response in the light of the replies and out of the data, as in Figure S6.3(b), we are left
arguments put forward by the other experts. with a cyclical seasonal variation. The mean
This process is repeated several more times deviation of each quarter from the trend line can
to conclude either with a consensus or at now be taken out, to give the average
least a narrower range of decisions. One seasonality deviation. What remains is the
refinement of this approach is to allocate random variation about the trends and
weights to the individuals and their seasonality lines, Figure S6.3(c). Future sales
suggestions based on, for example, their may now be predicted as lying within a band
experience, their past success in forecasting about a projection of the trend, plus the
and other people’s views of their abilities. seasonality. The width of the band will be a
The obvious problems associated with this function of the degree of random variation.
method include constructing an appropriate
questionnaire, selecting an appropriate panel
of experts and trying to deal with their
inherent biases.

4. Scenario Planning
- One method for dealing with situations of
even greater uncertainty is scenario
planning. This is usually applied to long-
range forecasting, again using a panel. The
panel members are usually asked to devise a
range of future scenarios. Each scenario can
then be discussed, and the inherent risks A. Forecasting unassignable variations
considered. Unlike the Delphi method, The random variations which remain
scenario planning is not necessarily after taking out trend and seasonal effects
concerned with arriving at a consensus but are without any known or assignable cause.
looking at the possible range of options and This does not mean that they do not have a
putting plans in place to try to avoid the cause, however, just that we do not know
ones that are least desired and taking action what it is. Nevertheless, some attempt can be
to follow the most desired. made to forecast it, if only on the basis that
future events will, in some way, be based on
5. Sales Force Composite past events. We will examine two of the
- Salespeople are a good source of more common approaches to forecasting
information with regard to customers’ future which are based on projecting forward from
intentions to buy a product. past behavior. These are:
6. Customer Surveys o Moving- Average
- By using a customer survey, a firm can base The moving-average approach to
its demand forecast on the customers’ forecasting takes the previous n periods’
purchasing plans. actual demand figures, calculates the
average demand over the n periods, and

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 uses this average as a forecast for the effect, the weight which is given to
next period’s demand. Any data older the last (and therefore assumed to be
than the n periods plays no part in the most important) piece of information
next period’s forecast. available to the forecaster. However,
the other expression in the formula
The following table shows the includes the forecast for the current
weekly demand for Euro speed, a European- period which included the previous
wide parcel delivery company. It measures period’s actual demand, and so on.
demand, on a weekly basis, in terms of the In this way all previous data has a
number of parcels which it is given to (diminishing) effect on the next
deliver (irrespective of the size of each forecast.
parcel). Each week, the next week’s demand The following table shows the data
is forecast by taking the moving average of for Euro speed’s parcels forecasts
the previous four weeks’ actual demand. using this exponential-smoothing
Thus, if the forecast demand for week t is F t method, where a = 0.2.
and the actual demand for week t is At, then:

For example, the forecast for week

35 is:
For example, the forecast for week
35:

The value of a governs the balance between the

responsiveness of the forecasts to changes in
o Exponential Smoothing demand, and the stability of the forecasts. The
There are two significant drawbacks closer a is to 0 the more forecasts will be
to the moving-average approach to dampened by previous forecasts (not very
forecasting. First, in its basic form, it sensitive but stable). The following figure shows
gives equal weight to all the previous the Euro speed volume data plotted for a four-
n periods which are used in the week moving average, exponential smoothing
calculations (although this can be with a = 0.2 and exponential smoothing with a =
overcome by assigning different 0.3.
weights to each of the n periods).
Second, and more important, it does
not use data from beyond the n
periods over which the moving
average is calculated. Both these
problems are overcome by
exponential smoothing, which is also
somewhat easier to calculate. The
exponential-smoothing approach
forecasts demand in the next period
by taking into account the actual
demand in the current period and the
2. Causal Models
forecast which was previously made
for the current period. It does so
Causal models often employ complex
according to the formula:
techniques to understand the strength of
relationships between the network of variables
where a = the smoothing constant. and the impact they have on each other. Simple
The smoothing constant a is, in regression models try to determine the ‘best fit’

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 expression between two variables. For example, 2. Simple Linear Regression
suppose an ice-cream company is trying to Regression analysis is a widely used tool
forecast its future sales. After examining for analyzing the relationship between
previous demand, it figures that the main variables for prediction purposes. In
influence on demand at the factory is the another example of revenue forecasting
average temperature of the previous week. To methods here, we will look at the
understand this relationship, the company plots relationship between radio ads and
demand against the previous week’s revenue by running a regression analysis
temperatures. This is shown in the figure below. on the two variables.
Using this graph, the company can make a
reasonable prediction of demand, once the
average temperature is known, provided that the
other conditions prevailing in the market are
reasonably stable. If they are not, then these
other factors which have an influence on Please refer to the following illustration.
demand will need to be included in the
regression model, which becomes increasingly
complex.

Continuing the illustration, we can now

plot the given set of data to the model.

These more complex networks comprise many

variables and relationships, each with their own
set of assumptions and limitations. While
developing such models and assessing the
importance of each of the factors and
understanding the network of interrelationships
is beyond the scope of this text, many 16. Forecast Accuracy
techniques are available to help managers
undertake this more complex modelling and also
feedback data into the model to further refine
and develop it, in particular structural equation
modelling.
Forecast bias – persistent tendency for forecast to
15. Other Forecasting Methods be greater or less than the actual values of a time
1. Straight line method series.
The straight-line method is one of the Forecast error – difference between the actual value
simplest and easy-to-follow forecasting and the value that was predicted for a given period.
methods. A financial analyst uses historical
figures and trends to predict future revenue Forecast error measures:
growth. A. Bias – indicates on an average basis,
whether the forecast is too high (negative
In the example provided below, we will look bias indicates over forecast) or too low
at how straight-line forecasting is done by a (positive bias indicates under forecast).
retail business that assumes a constant sales The Running Sum of Forecast Errors
growth rate of 4% for the next five years. (RSFE) provides a measure of forecast
A. The first step in straight-line forecasting bias.
is to find out the sales growth rate that
will be used to calculate future revenues.
B. To forecast future revenues, take the
previous year’s figure and multiply it by
the growth rate. B. Mean Absolute Deviation (MAD) –
indicates on an average basis, how many
units the forecast is off from the actual
data.
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 . . . considerable inertia in most economic and
natural phenomena. Thus, the present states of any
variables are predictive of the short-term future (i.e.
three months or less). Rather simple mechanistic
methods, such as those used in time series forecasts,
can often make accurate short-term forecasts and
Please refer to the given example: even out-perform more theoretically elegant and
elaborate approaches used in econometric
forecasting.
Long-term forecasting methods, although
difficult to judge because of the time lapse between
the forecast and the event, do seem to be more
amenable to an objective causal approach. In a
comparative study of long-term market forecasting
methods, Armstrong and Grohman conclude that
C. Mean Absolute Percentage Error econometric methods offer more accurate long-
(MAPE) – indicates on an average basis, range forecasts than do expert opinion or time series
how many percent the forecast is off from analysis, and that the superiority of objective causal
the actual data methods improves as the time horizon increases.

D. Mean Squared Error (MSE) – a

forecast error measure that penalizes large
errors proportionately more than small
errors

Please refer to the given example:

Forecasting models are widely used in

management decision making, and indeed most
decisions require a forecast of some kind, yet the
performance of this type of model is far from
impressive.

Hogarth and Makridakis, in a comprehensive review

of the applied management and finance literature,
show that the record of forecasters using both
judgement and sophisticated mathematical methods
is not good. What they do suggest, however, is that
certain forecasting techniques perform better under
certain circumstances. In short-term forecasting
there is:

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