Industrial Management and

Engineering Economy

Chapter Three:
Forecasting
Introduction
• All decisions about the process – and about
every other aspect of planning – depend on
future product demand.
• However, the demand for a product varies over
time, and there is usually no way of knowing
exactly what will be at any point in the future.
The best anyone can do is to make a forecast of
the likely value.
• Forecasts estimate the future levels of demand
for products.
• Production planning sets the future levels of
production, and organizes the resources needed
to achieve these.
Introduction…
Good forecasts enable managers to plan and budget
for appropriate levels of personnel, raw materials,
capital, inventory and a lot of other variables.
Meaning of forecasting
In Industrial management, Forecast is an
assessment of the expected pattern of future events
and the way(s) in which they might have effects on
the operations of the enterprise, or section of it.
It is not possible to anticipate or to foresee the
future exactly; but the more accurate the forecasting
the lower will be the possibilities of formulating
reliable plans; and, in consequence the greater will
be the chances of achieving the enterprise’s
objectives.
Use of forecast

Forecasting:
- is an essential component of planning by
managers;
- It helps to deal successfully with expected future
events, and to take steps to deal with any
problems which are anticipated to arise in the
future or even to avoid them before they arise.
 Forecasting techniques

There are basically two broad categories of

forecasting techniques. These are:
 Qualitative Methods
 Quantitative Forecasting Methods;
Qualitative Methods
- Qualitative/Judgemental forecasts are based on
subjective views, often the opinions of experts in the
field.
- It used when sufficient information and data is not
available;
- There are different ways of forecasting future
demand based on qualitative methods. This
includes:
A. Delphi method
- The technique draws on a panel of experts;
- Conducted in the way that eliminate possible
dominance of the most verbal or prestigious person
Qualitative Methods…
B. Jury of executive opinion
- is the method by which the relevant opinions of experts
are taken, combined and averaged;
- is fast, less expensive and does not depend up on any
elaborate statistics and brings in specialized view points;
C. Market survey
- involves the use of questionnaires, formation of consumer
panels, and testing of new products and services;
- It identifies the nature of the consumer consumption;
- A forecast is developed after determining how general
sales vary with differences in market location, buyer
occupation, commodity prices, quantity, quality consumer
income, and other factor.
Qualitative Methods…
D. Opinions of Salesperson
- involves the opinions of the sales force and these
opinions are primarily taken into consideration for
forecasting future sales;
- are good for short range planning since sales
people are not sufficiently sophisticated to predict
long term trends;
E. Historical Analogy and life cycle Analysis
- Use the product life cycle analysis (i.e. introduction,
growth, maturity and decline) for future demand;
Qualitative Methods…
Each of the above qualitative/ judgmental methods
works best in different circumstances. If a quick
reply is needed, Opinions of Salesperson is the
fastest and cheapest method. If reliable forecasts
are needed, it may be worth the time and effort of
organizing a market survey or Delphi method.
 Quantitative Methods

- use statistical analysis and other mathematical

models to predict future events;
- includes time series/Projective Method and
Casual forecasting Method.
A. Time Series forecasting Methods
- It is based on the assumption that past activities are
good indication of future activities;
- For e.g. If demand for a product over the past three
weeks has been 100, 110 and 120 units, it seems
reasonable to suggest that demand next week will be
around 130 units.
Quantitative Methods…
The components of a time series are
generally classified as
• Trend , T is a gradual long-term directional
movement in the data (growth or decline).
• Seasonal , S effects are similar variations
occurring during corresponding periods,
e.g., December retail sales. Seasonal can
be quarterly, monthly, weekly, daily, or
even hourly indexes.
Quantitative Methods…
• Cyclical ,C factors are the long-term
swings about the trend line. They are often
associated with business cycles and may
extend out to several years in length.
• Random ,R component are unpredictable
effects due to chance and unusual
occurrences.
Quantitative Methods…
Following are the steps in time series forecasting:
• Plot historical data to confirm relationship (e.g., linear,
exponential).
• Develop a trend equation (T) to describe the data.
• Develop a seasonal index (SI, e.g., monthly index
values).
• Project trend into the future (e.g., monthly trend
values).
• Multiply trend values by corresponding seasonal
index values.
• Modify projected values by any knowledge of :( C)
Cyclical business conditions, (R) Anticipated irregular
effects.
Quantitative Methods…
Methods of time series forecasting includes the
following:
A. Moving Averages
- is obtained by summing and averaging the values
from a given number of periods repetitively, each
time deleting the oldest value and adding a new
value;
- smooth out fluctuations in any data, while
preserving the general pattern of the data (longer
averages result in more smoothing);
Quantitative Methods…
Quantitative Methods…
Where, n= the chosen number of periods
t= 1 is the oldest period in the n-period
average
Di= the demand in the ith period.
Draw back of Moving average
- all historical values are given the same weight;
and method only works well with stable demand.
Quantitative Methods…
Example: 2.1. Shipments (in tons) of welded tube
by an aluminum producer are shown below:

Prepare a forecast using three years and a five

years moving average to forecast the fourth year
and the sixth year of demand.
Quantitative Methods…
Year Shipment 3-year moving 3-year MA 5-year moving 5-year MA
(tons) total total

1 2 - - - -

2 3 - - - -

3 6 11 3.7 - -

4 10 19 6.3 - -

5 8 24 8.0 29 5.8

6 7 25 8.3 34 6.8

7 12 27 9.0

8 14 33 11.0

9 14 40 13.3

10 18 46 15.3

11 19 51 17.3
Quantitative Methods…
B. Weighted moving average (MAw)
- It allows some values to be emphasized by
varying the weights assigned to each component
of the average;

- This model allows uneven weighting of demand.

Quantitative Methods…
Example: 2.2 using a weight of 3 for the most
recent data, 2 for the next, and 1 for the oldest,
forecast shipments in year 12 for the above
example 2.1.
Solution:
Quantitative Methods…
Or WMA=each period’s times a weight, summed
overall periods in the moving average

Where, Ct is between 0 and1

Quantitative Methods…
For example, in the previous example, n is three
years; we could weight the most recent period
twice as heavily as the other periods by setting
C1=0.25, C2=0.25, C3=0.5. Thus, a forecast of
demand for the twelfth year using a three-period
model with the most recent period’s demand
weighted twice heavily as each of the previous
two years’ demand is:
 Quantitative Methods…
C. Exponential smoothing
-It is based on the idea that as data gets older it
becomes less relevant and should be given less
weight.
- is a modified moving average forecasting technique,
weighing each past data exponentially, so that the
most recent data carry more weight in the moving
average and the weight placed on successively
older periods decrease exponentially.
Quantitative Methods…

Where, α= the smoothing constant and α is

between 0 and 1
t= the period
At-1 :last period actual demand
Ft-1 , last period forecast
Ft forecast
Quantitative Methods…
The selection of α depends up on the
characteristics of demand. High values of α
are more liable to fluctuations in demand.
Low values of α are an appropriate for
relatively stable demand but with a high
amount of random variation.
Quantitative Methods…
Example: 2.3. HiTek computer services repairs and
services personal computers at its store, and makes
local service calls. It primarily uses part – time State
University students as technicians. The company
has had steady growth since it started. It purchases
generic computer parts in volume at a discount from
variety of sources whenever they see a good deal.
Thus, they need a good forecast of demand for
repairs so that they will know how many computer
component parts to purchase and stock, and how
many technicians to hire.
Quantitative Methods…
The company has accumulated the demand data
shown in the accompanying table for repair and
service calls for the past 12 months, from which it
wants to consider exponential smoothing forecasts
using smoothing constants (α) equal to 0.30 and
0.50.
Quantitative Methods…

PERIOD MONTH DEMAND

1 Jan 37
2 Feb 40
3 March 41
4 April 37
5 May 45
6 June 50
7 July 43
8 August 47
9 Sep 56
10 Oct 52
11 Nov 55
12 Dec 54
Quantitative Methods…
Solution

F2 = F3 =
= (0.30)(37) + (0.70)(37) = (0.30)(40) + (0.70)(37)
= 37 = 37.9

F13 =
= (0.30)(54) + (0.70)(50.84)
= 51.79
Quantitative Methods…
FORECAST, Ft + 1

PERIOD MONTH DEMAND (a = 0.3) ( = 0.5)

1 Jan 37 – –

2 Feb 40 37.00 37.00

3 Mar 41 37.90 38.50

4 Apr 37 38.83 39.75

5 May 45 38.28 38.37

6 Jun 50 40.29 41.68

7 Jul 43 43.20 45.84

8 Aug 47 43.14 44.42

9 Sep 56 44.30 45.71

10 Oct 52 47.81 50.85

11 Nov 55 49.06 51.42

12 Dec 54 50.84 53.21

13 Jan – 51.79 53.61

Quantitative Methods…

Causal Forecasting Methods

- It has a higher degree of accuracy due to
the fact that it measures the fundamental
factors and asserts their relationships to
the products under consideration.
- It is used for a short and medium range
forecasting of the existing products,
services, marketing strategies, production
and facility planning.
Quantitative Methods…
Regression methods
-is used for forecasting by establishing a
mathematical relationship between two or more
variables.
- Here we need to identifying relationships
between variables and demand;
Quantitative Methods…
- If we know that something has caused demand to
behave in a certain way in the past, we would like
to identify that relationship so if the same thing
happens again in the future, we can predict what
demand will be.
- For example, there is a relationship between
increased demand in new housing and lower
interest rates. Correspondingly, a whole myriad of
building products and services display increased
demand if new housing starts increase.
Quantitative Methods…
- The simplest form of regression is linear
regression
- Linear regression: is a mathematical
technique that relates an independent
variable to dependent variable, in the form of
an equation for a straight line.
Quantitative Methods…
A linear equation has the following general form;

Where, y= Predicted (dependent) variable

x = Predictor (independent) variable
b = Slope of the line
a = the intercept
- To develop the linear equation, first we
have to calculate a, and b;
Quantitative Methods…
Example 2.4: The general manager of a building
materials production plant feels that the demand
for plasterboard shipments may be related to the
number of construction permits issued in the
county during the previous quarter. The manager
has collected the data shown in Table below
(a) Compute values for the slope b and intercept a.
(b) Determine a point estimate for plasterboard
shipments when the number of construction
permits is 30.
Quantitative Methods…
Quantitative Methods…
Solution: a)
Quantitative Methods…
Quantitative Methods…
The choice of forecasting method depends
on the following factors:
- The time covered by the forecast;
- Availability and relevance of historical
data;
- Type of product, particularly the balance
between goods and services;
- Variability of demand;
- Accuracy needed and cost of errors;
- Benefits expected from the forecasts;
and
- Amount of money and time available.
End of Chapter Three
Thank You For your
attention!!!