Professional Documents
Culture Documents
Forecasting Fundamentals
Forecasting Fundamentals
Forecasting Fundamentals
Forecasting Fundamentals
Nada R. Sanders, PhD
Forecasting Fundamentals
Copyright Business Expert Press, LLC, 2017.
All rights reserved. No part of this publication may be reproduced,
stored in a retrieval system, or transmitted in any form or by any
meanselectronic, mechanical, photocopy, recording, or any other
except for brief quotations, not to exceed 400 words, without the prior
permission of the publisher.
First published in 2017 by
Business Expert Press, LLC
222 East 46th Street, New York, NY 10017
www.businessexpertpress.com
ISBN-13: 978-1-60649-870-5 (paperback)
ISBN-13: 978-1-60649-871-2 (e-book)
Business Expert Press Supply and Operations Management Collection
Collection ISSN: 2156-8189 (print)
Collection ISSN: 2156-8200 (electronic)
Cover and interior design by Exeter Premedia Services Private Ltd.,
Chennai, India
First edition: 2017
10 9 8 7 6 5 4 3 2 1
Printed in the United States of America.
Abstract
This book is for everyone who wants to make better forecasts. This book
is not about mathematics and statistics. It is about following a well-
established forecasting process to create and implement good forecasts.
This is true whether you are forecasting global markets, product demand,
competitive strategy, or market disruptions.
Today, most forecasts are generated using software. However, no
amount of technology and statistics can compensate for a poor forecasting process. Forecasting is not just about generating a number. Forecasters
need to understand the problems they are trying to solve. They also need
to follow a process that is justifiable to other parties and be implemented
in practice. This is what this book is about.
Business leaders know that accurate forecasting is a critical organizational capability. Forecasting is predicting the future, and the list of
what needs to be predicted to run a world-class organization is endless. Forecasting goes well beyond simply predicting demand or sales.
Accurate forecasts are essential for identifying new market opportunities,
forecasting risks, events, supply chain disruptions, innovation, competition, market growth, and trends. It also includes the ability to conduct
what-if analysis to understand the tradeoff implications of decisions.
Companies can navigate this daunting landscape and improve their forecasts by following some well-established principles and bearing in mind
certain caveats to conventional wisdom.
This book is written to provide the fundamentals business leaders need
in order to make good forecasts. These fundamentals hold true regardless
of what is being forecast and what technology is being used. This book
provides the basic foundational principles all companies need to achieve
competitive forecast accuracy.
Keywords
causal methods, collaborative forecasting, forecasting, forecast accuracy
measures, forecasting analysis, forecasting in business, forecasting
methods, forecasting process, forecasting technology, judgmental forecasting, time-series forecasting
Contents
Section I
Forecasting Basics 1
Chapter 1
Forecasting in Business3
Chapter 2
Section II
Chapter 3
Section III
Chapter 4
Chapter 5
Chapter 6
Section IV
Chapter 7
Technology in Forecasting91
Chapter 8
Notes119
References121
Index123
SECTION I
Forecasting Basics
CHAPTER 1
Forecasting in Business
My interest is in the future because I am going to spend the rest of
mylife there.
C.F. Kettering
What Is Forecasting?
Forecasting is the process of predicting the future. Any time we make a
prediction or estimate of a future event, we are forecasting. We are always
making forecasts even though we may not think of it in a formal way.
Here are some examples of forecasts.
Predicting the afternoons weather
Estimating how much time it will take to drive to a
friendshouse
The price of tomatoes at the grocery store tomorrow
Who will win the Presidential election?
When the new iPhone will go on sale?
Whether you will get a raise this year
In business, we often associate forecasting with predicting customer
sales or product demand. Although forecasting is certainly used to estimate sales and demand, forecasting involves predicting a much broader
set of issues. Just like in our personal life, any time we make a business
prediction we are forecasting. Here are some examples.
FORECASTING FUNDAMENTALS
Forecasting in Business 5
1. Forecasts are the foundation for all decisions. The reason forecasting is so important is that all other business decisions are based
on a forecast. In fact, a business decision cannot be made without
a forecast. Consider a company deciding how much to produce of
a product and in which markets to distribute that product in order
to maximize sales. In this case, many forecasts must be generated
for different markets and compared. Similarly a company may wish
to identify future customer trends to better design new products,
predict availability of key materials used in production, or identify
emerging competition to know how to better define its strategy.
Acompany may also need to anticipate events such as new regulations and tariffs, price increases by suppliers or supply shortages, and
disruptions that may prevent deliveries.
Perhaps a company in the food service industry has decided to
increase the amount of coffee it purchases in anticipation of a shortage due to a drought in South America. Maybe a rise in the cases of
the flu is prompting a vaccine manufacturer to increase production
of vaccines. Perhaps a university has chosen to expand its courses
in business analytics due to a forecast of a rise in demand for such
programs. All these decisions are based on a forecast of the future. In
fact, these decisions cannot be made without a forecast.
2. Forecasts impact decisions of different time frames and organizational levels. Forecasting is further complicated by the fact that
business decisions require both long-term and short-term forecasts. Long-term forecasts support strategic planning and include
decisions such as market trends, behavior and shifts in competitive
markets, emerging competition, and long-term expansions.
By contrast, short-term forecasts support tactical decisions. They
address questions such as how many stock keeping units or SKUs
of a product a retailer expects to selland therefore decide on how
much inventory to hold in stockor how many workers to schedule
for the next shift at a call center.
3. Forecast accuracy impacts cost and customer service. Improving
forecast performance has been shown to lead to significant benefits
for organizations. One benefit is lowering costs. Accurate forecasting
is an important element of cost control.
FORECASTING FUNDAMENTALS
Good forecasts
Reduce cost
Reduce waste (e.g., inventory, staff, materials, and processes)
Improve responsiveness
Improve customer service
Forecasting in Business 7
planning. Planning is the process of deciding on specific actions in anticipation of the forecast.
When we look at a weather forecast and anticipate rain, we plan by
carrying an umbrella. Similarly a business may order more items to stock
in anticipation of higher demand, such as higher ice cream sales in the
summer. Have you ever gone to a restaurant and been told that they are
sold out of their specials or gone to the bookstore and found that the
books are on backorder? These are examples of poor planning as a result
of poor forecasts. Planning for any event requires a forecast of the future.
Whether in business or in our own lives, we make forecasts of future
events. Based on those forecasts we make plans and take action.
In business we often confuse planning with forecasting. Business
managers often say something similar to the following: Our forecast is
to produce 6,000 units in the first quarter. This statement blurs the two
concepts. In this example, the plan is to produce 6,000 units, not the
forecast. The plan is what we are going to do whereas the forecast is a
prediction of what will happen.
Is it possible to influence the forecast? Of course it is. However, we need
to be clear on what is the forecastor predictionindependent of our
action. We need to separately understand the planwhich may in fact
include our influence. Without separating these we cannot understand
each of these variables and have an idea as to how we are performing.
Forecasts drive plans. Plans for the future are then made in response
to the forecast. This is shown in Figure 1.1.
Planning is the process of taking action in order to prepare for the
future. Planning requires organizing resources in anticipation of the forecast and being prepared for future events. Today organizations operate in
a global Internet-driven environment. They often need to respond in real
time and must decrease their vulnerability to chance. In order to do that
they need better forecasts and plan their resources accordingly.
Forecasting
Planning
FORECASTING FUNDAMENTALS
Forecasting in Business 9
Forecasting
Planning
Demand
management
Modifying the future
10
FORECASTING FUNDAMENTALS
Forecasting in Business 11
12
FORECASTING FUNDAMENTALS
Forecasting in Business 13
made by each company in the chain. When members of the supply chain
make their forecasts independent of one another, they are only looking at
the demand of their immediate buyer not the final customer in the chain.
The consequence is a mismatch between supply and demand because
each member of the chain is working to fulfill a different level of demand.
Consider the forecasting and planning process of Dell and Intel, one
of Dells suppliers. Dell starts its planning process with a forecast of future
demand which is used to determine order quantities. At the same time,
Intel, who supplies Dell with microprocessors, needs to determine its production and inventory schedules. If Dell and Intel were to make their
forecasts independently of one another, their forecasts would differ and
Intel would not be supplying Dell with the exact quantities of microprocessors it needs. The best alternative is for Dell and Intel to collaborate. When there is collaboration between suppliers and manufacturers
in generating the forecast, all entities are responding to the same level of
demand.
Independent forecasting by members of the supply chain gives rise to
the bullwhip effect. The bullwhip effect refers to the increased volatility
in orders as they propagate through the supply chain. The bullwhip effect
occurs when each individual company in the supply chain forecasts its own
demand, plans its stocking levels, and makes its replenishment d
ecisions
independently of other companies in the chain. This creates volatility in
orders which makes forecasting more difficult, leads to increases in inventory throughout the supply chain, has a higher stock-out risk, and results
in inefficient use of working capital and production capacity.
Forecasting Challenges
Implementation of a good forecasting process and correctly using the
right technology is a challenge for most companies. Methodological
advancements, available technology, and information access have in many
instances elevated forecasting capability. In practice, however, forecasting
processes still heavily rely on human judgment, despite the availability
of sophisticated forecasting methods. Forecasts within the practice are
usually produced as a combination of statistical forecasts and managerial judgment, where an initial statistical forecast is adjusted based on
opinions. Often forecasts are made by the opinions of managers without
14
FORECASTING FUNDAMENTALS
Discussion Questions
1. What is forecasting? Why is it important to everyone? Why is it
important to business leaders?
2. Provide at least three examples of forecasts you have made over the
past week. Remember that this does not include a formal f orecasting
process but any predictions or estimates you have made in your personal life.
Forecasting in Business 15
3. Select one of the examples you provided and explain the planning
process you went through in order to prepare for the forecast you
made.
4. Provide examples of business forecasts. Explain the kind of plans the
business would need to respond to these forecasts.
5. Explain demand management. How does it impact the forecast and
planning process?
6. Provide an example from your life as a consumer where you
responded to demand management.
7. Give examples of forecasting outside of the business context. Explain
why these forecasts are important and what their planning process
would be.
8. Explain why companies in a supply should collaborate for forecasting. Does this provide benefits and why? Provide an example of
companies that engage in such collaboration.
9. What is the bullwhip effect and how can forecasting help?
10. What was the mistake that Nike made in the example provided? Why
was this important and how should companies use their forecasts?
Index
Accuracy, forecasting, 6, 19
measuring, 3147
monitoring, 25
Additive models, 79
Adjusting statistical forecasts, 6163
depends upon data type, 62
documenting, 62
limiting number of series, 63
monitoring, 62
only high volatile series, 63
only most important forecast, 63
structuring, 62
with domain knowledge, 61
with high degree of uncertainty, 61
with known environmental
changes, 62
Adjustments
outliers, 22
trading day, 22
Analytics, 9495
Average performance, 32
Benchmarking performance, 32
Big data, 9394
Black swan, 98
Brainware, 103
Bullwhip effect, 13
Business intelligence, 9697
Capability, 27
Causal models, 7879
linear regression, 8586
multiple regression, 8687
Centre for Disease Control (CDC), 9
Climate change, 11
Cloud computing, 96
Coefficient of variation (CV),
109111
Collaborative forecasting, 113115
collaborative planning, forecasting,
and replenishment (CPFR),
113114
124 Index
Digital trails, 94
Domain knowledge, 57, 7273
Executive opinion, 7071
Explanatory models, 7879
Exponential smoothing, 8283, 91
Facebook, 93
Finance, 11
Fit set, 35
Fit versus forecast accuracy, 3335
Forecast accuracy, 3147
fit versus, 3335
importance of, 32
out-of-sample evaluation, 35
steps in, 3638
deciding on fit and test period,
37
future forecast, 38
generate forecast for test period,
38
measuring future accuracy, 38
multiple forecast results in test
period, 38
statistically describing data set,
3637
Forecast error measure, 3847
comparing, 4647
interpreting, 4546
standard error measures, 3840
using, 4146
Forecastability, 32, 109, 110
Forecasting
accuracy in, 6, 19
challenges, 1314
collaborative, 113115
climate change, 11
crime, 11
decisions in conflicts, 12
defined, 34
drive plans, 7
error, 31
health, 12
impact
across industries, 1112
on organization, 1011
on supply chain, 1213
importance of, 46
Index 125
Intel, 13
Internet of Things (IoT), 94
Judgmental adjustment of quantitative
forecasts, 5860
Judgmental forecasting methods, 51,
5253
basics of, 6566
strengths and weakness, 6669
types of, 7072
Delphi method, 72
executive opinion, 7071
market research, 7172
use in practice, 6970
Judgmental input to model building,
6061
Level patterns, 23
Level time series models, 8083
exponential smoothing, 8283
mean, 8081
moving averages, 8182
Limited attention span, 68
Linear regression, 8586
Long-term forecasts, 5
M&Ms, 8
MAD. See Mean absolute deviation
MAPE. See Mean absolute percentage
error
Marketing, 10
Mars Inc., 8
Mean, 36, 8081
Mean absolute deviation (MAD), 39
Mean absolute percentage error
(MAPE), 41
Mean percentage error (MPE), 4041
Mean squared error (MSE), 3940
Missing data, 21
Moore, Gordon E., 96
Moores Law, 96
Moving averages, 8182
simple, 8182
weighted, 82
MPE. See Mean percentage error
MSE. See Mean squared error
Multiple layers of seasonality, 107
Multiple regression, 8687
Nave method, 45
National Oceanic and Atmospheric
Administration (NOAA),
98
Nike, 14
Occams Razor, 7576
Operations, 11
Optimism, 68
Organization, forecasting impact on,
1011
Out-of-sample evaluation, 35
Outliers (or special event)
adjustments, 22
Patterns, data, 2224
cycles, 23
level or horizontal, 23
random variation, 2324
seasonality, 23
trend, 23
PepsiCo Inc., 18
Planning
defined, 7
forecasting versus, 69
relationship between forecasting
and, 910
Point of sale (POS), 91
Political forecasting, 12
Political manipulation, 68
Predictive analytics, 9798
Principle of Parsimony,
7576
Qualitative forecasting methods,
6574
Radio frequency identification
(RFID), 91
Range, 36
Regression, 98
Relative error measures,
4041
Responsiveness, 76
S&OP. See Sales and operations
planning
126 Index