Forecasting Models

Introduction
Forecasting can be termed as prediction of future sales or demand of a product. It is a
projection based upon the past data and the art of human judgment. The survival of any
organization depends upon how well they are able to project the demand in future.

Advantage of forecasting

1. Forecasting determines the volume of production and the rate at which it is to be

produced.

2. It helps in determining the basis for material project, labor project, production budget
etc.

3. Suggest the need for plant expansion.

4. Helps in determining price policy.

5. Essential for product design and development.

6. Helps in determining the extend of marketing, advertising and distribution required.

Types of Demand variation

1. Trend variation: It shows a long term upward or downward trend in a product sales
on a continuous scale.
2. Seasonal variation: This type of variation shows the short term regular variation in
sales with respect to a time of a day or day of a week.

3. Cyclic variation: It shows a long term wave like demand variation, normally lasting
for more than a year.

4. Irregular: This type of demand variation is caused by sudden unusual circumstances

that are different from the normal behavior such as government policy change, price
hike, strike, shutdown, severe weather conditions etc.
 Types of forecasting

Forecasting

Qualitative or subjective Quantitative or objective

Judgmental

Time series Causal or econometric

Opinion Survey
Past Average Correlation
Market trial Moving Average Regression

Market research Weighted moving average

Exponential Smoothing
Delphi technique

Note:

1. Qualitative or subjective techniques are employed for long term (1-5 years)
forecasting.
2. Quantitative or objective techniques are used for short term (1-3 months) and mid-
term (3-12) forecasting.

Judgmental

This method is preferred for forecast of new product and this technique is based purely
on the art of human judgment i.e. how well a human being can predict the demand of a
product in future. This method does not require past data or sales figure.

(i) Opinion survey: In this method opinions are collected from the customer, from a
retailer and distributor regarding the demand pattern of a product and this information
is used to get the forecast.

(ii) Market trial: This method is applicable for new product and in that case product is
introduced between a limited population in the form of free samples. The response
from the limited population is used to project the demand from a bigger population. It
is applied for low cost consumables like toothpaste, cold drink, cosmetic item etc.

(iii) Market research: In this method the survey work is assigned to external marketing
agencies and purpose of research is to collect the information regarding the demand of
a product. The details about various factor which influence the demand like customer
income, occupation, location, quality, quantity etc. are related to get the forecast.

(iv) Delphi technique: In this method a panel of experts is asked sequential questions
in which the response to one question is used to produce next question. The
information available to some expert is made available to others. It is a step by step
procedure in which opinions are collected from the experts to reach a reliable forecast. If
the experts are willing to cooperate, this is the best technique for forecasting of new
product.

Time Series
In this method, past data is arranged in chronological order as dependent variable and
time as independent variable. Based on the past data we project the demand in future.
(i) Past average method: In this method forecast for any period (t) is equal to average
actual demand of a product for the previous periods.

Year Actual demand (D) Forecasted demand (F)

1. 2003 108 -
2. 2004 127 -
3. 2005 113 117.5
4. 2006 121 116

F2005 = = 117.5

F2006 = = 116

(ii) Simple moving average: This method uses past data and calculates a moving
average for a constant period. Fresh average is computed at the end of each period by
adding the actual demand data for the most recent period and deleting the data for
older period. In this method as data changes from period to period, it is called moving
average method.
If n = number of period, then first forecast = (n+1)th period.
For n= 3, first forecast will be from 4th period.

Year Actual demand (D) Forecasted demand (F)

1. 2003 108 -
2. 2004 127 -
3. 2005 113 -
4. 2006 121 116
5. 2007 129 120.33
6. 2008 143 121
F2006 = = 116

F2007 = = 120.33

F2008 = = 121

(iii) Weighted moving average: This method gives unequal weight to each demand
data in such a manner that the summation of all weights always equals to one. The most
recent data is given the highest weight and the weight assigned to the oldest data is the
least.
If n = number of periods, then first forecast = (n+1)th period.
Method to find the weights
1) Find the summation of n natural numbers
∑ = n (n+1)/2
2) Arrange in decreasing order as

∑
, ∑
, ∑
, ∑
…………….. ∑

Example: For n = 4, first forecast will be from 5th period and ∑ = 10

, , ,

Year Actual demand (D) Forecasted demand (F)

1. 2003 108 -
2. 2004 127 -
3. 2005 113 -
4. 2006 121 -
5. 2007 129 118.5
6. 2008 143 123.2
F2007 = 0.4* 121 + 0.3*113 + 0.2*127 +0.1*108 = 118.5
F2008 = 0.4* 129 + 0.3*121 + 0.2*113 +0.1*127 = 123.2

(iv) Exponential Smoothing: In this method we require only the actual demand data
and the forecasted value for the last period to get the next forecast. This method gives
weight to all the previous data and the weight assigned are in exponentially decreasing
order. The most recent data is given the highest weight and the weight assigned to
older data decreases exponentially.
General case:
Forecast (F) at any period (t) is given by

Ft t-1 - t-2 - 2D
t-3 - 3D
t-4 + ……….∞
Ft t-1 + (1- t-2 - Dt-3 - 2D
t-4 + ……….∞ }
Ft t-1 + (1- t-1

Ft = Ft-1 t-1 - Ft-1 }

Since

Forecast error, et = Dt - Ft
Therefore,

Ft = Ft-1 { et-1 }

Where

Ft-1 is forecasted value for the previous period (t-1)

is known as smoothing constant and is equivalent to

𝟐
𝐧 𝟏

n = number of period
Note:
If for the initial period forecast value is not known then it can be determined by either
of the following methods:
Ist Method (Naïve Method): Take the actual demand data for the first period equal to
the forecast for the first period i.e. take D1 = F1 and proceed.

IInd Method: Take the mean or average value of actual demand data as the forecast for
first period and proceed.

For = 0.3

Year Actual demand (D) Forecasted demand (F) Error (e)

1. 2003 100 100 0
2. 2004 120 100 20
3. 2005 90 106 -16
4. 2006 145 101.2 43.8
5. 2007 160 114.34 45.66
6. 2008 - 128.03 -

F2003 = D2003 (Applying Naïve method)

F2004 = F2003 + 0.3 (0) = 100
F2005 = F2004 + 0.3 (20) = 106
F2006 = F2005 + 0.3 (- 16) = 101.24
F2007 = F2006 + 0.3 (43.8) = 114.34
F2008 = F2007 + 0.3 (45.66) = 128.03

Responsiveness and stability

(i) Responsiveness: It indicates that the forecast have a fluctuating pattern.

Responsiveness is preferred for new product and for that number of period is kept
small.
(ii) Stability: It means that the forecast pattern is flat or has less fluctuation. Stability is
preferred for old exiting product and for that number of periods is kept large.

Responsive n1 1
Demand

Stable

n2 2

New product
n1 < n2
1 > 2 Old product

Time

As

and

Ft = Ft-1 Dt-1 - Ft-1 }

1. If = 1, n= 1 (limit of responsiveness)
Ft = Dt-1

2. If = 0, n=∞ (limit of stability)

Ft = Ft-1
Forecast error
Forecast error is used to find the pattern which may regulate our future production. The
error should be minimum as far as possible and the most generally used techniques to
find forecast error are:

1) Mean Absolute Deviation (MAD):

D F e
1. 90 120 -30
2. 130 100 +30

MAD = |-30| + 30
= 60

MAD = ∑

It tells the absolute magnitude of forecast error for certain number of periods (without
considering sign).

2. Mean Forecast Error (MFE) or Bias:

MFE or Bias = ∑

It only tells the direction of forecast error and shows any tendency of over forecast or
under forecast. Positive bias means under estimated forecasting and negative bias
means over estimated forecasting.

Running sum forecast error (RSFE) = ∑

and
Bias =
3. Mean Square Error (MSE)

MSE = ∑

It is used to plot control chart for forecast error and nowadays it is the most used one.

4. Mean absolute percentage error (MAPE)

MAPE = ∑

It is the mean of percentage error or deviation as compared to actual demand and it is

used to compute error with respect to demand because there is difference between 50
out of 100 and 50 out of 1000.

4. Traffic Signal (TS)

TS =

It tells how well the forecast is predicting the actual value. A value of ‘zero’ is ideal but
4 or is the acceptable range.

References
1. Industrial Engineering and Management by O.P. Khanna

2. NPTEL Videos