Dr. M. Ahsan Akhtar Hasin, IPE, BUET.

Chapter 13
Forecasting
Introduction
Forecast means prediction or estimation about anything in future. In operations
management, forecast is necessary for anticipating demand of products or services. It is
in fact the first level planning, since all subsequent plans depend on this. Bear in mind
that some level of inaccuracy may be present in forecast. However, it is better to
minimize this inaccuracy as much as possible.

Forecast is vital, because it is the basis for long-term planning. It is required for every
department in the organization. This demand estimation acts as the input for other
functions or departments, as explained below:

 Marketing/sales need to forecast demand of products in the market, because

appropriate sales arrangement must be in place beforehand.
 Distribution needs to know the amount to stock to be kept to fulfill demand in the
next periods. Because all logistical arrangements, including transportation, must
be in place on time.
 Production planner also needs this forecast demand for production planning
purpose, which will determine the target production volume in a period. All
production resources must be planned accordingly.
 Finance also needs to know forecast values for budgetary allocation.
 Inventory relies on production plan, based on forecast, to stock amount of
materials.
 Procurement department needs to know forecast, because amount and timings of
procurement of materials depend on that.

Thus, forecast is vital for many departments.

Components of Demand / Demand Patterns

In most cases, demand for products and services can be broken down into five
components, or can follow five patterns:

1. Trend – Trends are such a pattern that increase or decrease with time. Demands of
most of the products or services in the world have some pattern of trend. For
instance, demands of televisions, mobile phones, camera, apparels, chairs/tables,
computers, etc. have trend. However, increase or decrease may take place either
linearly (in a straight line), or non-linearly (in a curve).

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Dr. M. Ahsan Akhtar Hasin, IPE, BUET.

a) Linear trend – If demand increases or decreases uniformly with time, then

it has Linear trend, either Linear Increasing trend, or Linear decreasing
trend. A linear trend is obviously a straight continuous relationship. Linear
increasing trend means that demand of the product increases at a constant
rate with time. For example, demands of chair, television, etc. increase
linearly with time.

On the other hand, linear decreasing trend means that demand of the
product decreases at a constant rate with time. For example, demand of
wrist watch is decreasing linearly with time.

b) Nonlinear trend – If demand changes at a constant percentage, then it

looks like a curve, either Asymptotic or Exponential. In case of
Asymptotic change, initially after introduction of the product, demand
increases rapidly, then slows down for any reason. For instance, demand
of Teletalk mobile phone.

On the other hand, in case of Exponential change, initially after

introduction of the product, demand increases very slowly, and then grows
very fast after some time for any reason. For instance, demand of mobile
phone in general.

2. Seasonal – Demand of this type of product goes up and down depending upon
seasons of the year. For instance, demand of an umbrella goes up in the rainy
season, whereas its demand goes deep down in the winter. Demand of cold drinks
goes up in the summer, but goes down in the winter.

However, pattern changes four times a year.

3. Cyclical – Graphically, Cyclical pattern looks like seasonal, although Cyclical

demand pattern goes up or down once after several years. Cyclical factors are
more difficult to determine, because the time span may be unknown. A very few
products belong to this category. Fashion products follow this pattern.

4. Random – Random variations are caused by chance events. Statistically, it is the

unknown part of demand, which is beyond explanation. In this case, demand goes
up and down frequently in small margin. All most all types of products have this
pattern in their demand; e.g. grocery items, foods, etc.

5. Combined – In reality, every product follows a combination of many patterns

together. It is rather uncommon to find a product which follows a single pattern of
demand change. For instance, cold drinks have Increasing Trend, Seasonal
pattern, as well as Random pattern (random change).

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 Dr. M. Ahsan Akhtar Hasin, IPE, BUET.

1) Linear trend 2) Asymptotic trend/Exponential trend

Demand Increasing

Demand
Asymptotic

Decreasing Exponential

Time
Time

3) Seasonal trend (Quarterly change) 4) Cyclic component/ pattern

Demand

Demand

Time (Quarters) Time (Years)

5) Random pattern
Demand

Time

6) Combined (Combination of many patterns)

Demand

Time
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Dr. M. Ahsan Akhtar Hasin, IPE, BUET.

Types of Forecasting
Two basic types:
1. Qualitative
2. Quantitative

 Qualitative

These are Subjective, judgmental techniques, based on estimations or opinions,

derived from experience, especially when past data are not available.
a) Grass root – Drives a forecast by compiling inputs from the persons at the end
of the hierarchy. For example, an overall sales forecast may be derived by
combining inputs from each salesperson, who works closest to the market or
consumer.
b) Market Research – It is done by conducting Survey or Interview, using
questionnaire. The collected data are analyzed statistically, and then a decision
is taken.
c) Historical analogy – An analogy (comparison) is prepared from past historical
experience, learnt by selling a similar product in the past, or in a similar
market.
d) Panel consensus – It is based on the idea that two heads are better than one.
Thus, a committee of experts is formed, comprising top executives having
direct relevance with demand. Free open exchange of views take place at face-
to-face meetings. This is also known as “Jury of Executive Opinion” or
“Executive Judgment”.
e) Delphi method – This is partly similar to Panel consensus. However, meetings
are avoided. Group of experts responds to questionnaire. It can avoid influence
of top executives.

 Quantitative

These are based on analysis of past records or data or mathematical methods. A

person has no scope to express subjective judgment. These may be of many types
again:

a) Time series analysis – These techniques are based on the idea that past records will
continue in future, or past history will be applicable in future. Time series
forecasting models try to predict the future based on past data. There are
different techniques:
i. Simple Moving Average (MA)
ii. Weighted Moving Average
iii. Exponential Smoothing
iv. Regression Analysis
v. Etc.

b) Causal relationships – These techniques recognize that forecast or demand is not

only a variable of “time”, but also many other factors. Thus, these try to
understand how surrounding elements affect forecasting, e.g. Sales may be

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Dr. M. Ahsan Akhtar Hasin, IPE, BUET.

affected by advertising; sales promotion or discount may suddenly influence

demand, etc. There are many such methods, e.g.
i. Econometric models,
ii. Input-Output model, etc.

c) Simulation – These are based on Computer-based modeling (using computer

programming) and analysis on huge amount of past data, which can simulate the
behavior of data (pattern of demand). Then, based on that behavior, learnt
through simulation, the program can estimate future demand.

How to choose a method ?

Which forecasting method/model should be used, depends on some characteristics or
attributes. Those are:

 Time horizon to forecast – Length of period of estimation, such as long-term,

short-term, medium, etc.
 Data availability – How many periods’ data is available on-hand for analysis.
 Accuracy required – How much accurate we want to be in our future
prediction, or forecast/output. Generally, the higher the accuracy required, the
more complex a technique should be selected.
 Demand characteristics – The pattern of demand, such as increasing trend,
asymptotic trend, seasonal pattern, etc. largely influence selection of a method.
 Size of forecasting budget, and availability of expertise for analysis.

 Simple Moving Average (MA)

When demand for a product is neither growing, nor declining rapidly, and if it does
not have seasonal effect, then this method is applicable. This assumes that recent
demand data are more useful in predicting future demand. Here, an average of 3
periods is selected.

Weeks Demand/actual 3 week MA

sales forecast
1 1200
2 1400
3 1000
4 1500 1200
5 1500 1300
6 1300 1333
7 1600 1433
8 1700 1467
9 1500 1533

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Dr. M. Ahsan Akhtar Hasin, IPE, BUET.

 Exponential Smoothing
The major drawback of the previous method is the need to continually carry a large
amount of historical data. If limited amount of data is available, and the most recent
data should be given importance, then Exponential Smoothing is more suitable. This
is the most used of all forecasting techniques. For example, it is widely used in
ordering inventory in retail firms, wholesale companies, and service agencies.

Here, Ft = α At-1 + (1- α) Ft-1

Where, Ft = Forecast for the next period (week, month, quarter, year, etc.),
Ft-1 = Forecast for the previous period,
At-1 = Actual demand/sales for the previous period
α = Smoothing constant (0-1)

Smoothing constant is basically a “weightage” or “importance” assigned to actual

demand and forecast. The value of α can be found through computer simulation using
past pattern analysis, or expert opinion. This method is surprisingly good, especially if
no rapid changes in demand take place.

Example: Last month’s forecast and actual sales were 1050 units and 1000 units
respectively. Given, α = 0.05 (past experience). What is the forecast amount for this
month ?

Ft = α At-1 + (1- α) Ft-1 = 0.05 x 1000 + (1-0.05) 1050 ≈ 1048 units

 Regression Analysis
This is also known as “Linear Regression Analysis”. The Least Squares Method is a
Regression analysis method. This basically correlates two important demand data:
demand (amount) vs. time.

This assumes that what ever happened in the past, will continue to happen in the
future. This may not always be true.

This is specially useful for linear trend (uniform increasing or decreasing). It is useful
for long-term forecasting of major occurrences and aggregate production planning.
For example, linear regression would be very useful to forecast demands for product
families (a group of similar products).

Here, Y = a + bx ….equation of a straight line, Y

(amount)
Where, y is demand, x is time; a and b are constants.

Where, b 
 xy  nx y ; a  y  bx
 x  nx
2 2
x (time)

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Dr. M. Ahsan Akhtar Hasin, IPE, BUET.

Example: Demands of the past 1 year (in 12 months, starting from January of that
year, up to December of that year) are given.

a) Find the Regression equation

b) Calculate the demand of January of next year

x (month) y (Sales) xy x2
1 600 600 1
2 1550 3100 4
3 1500 4500 9
4 1500 6000 16
5 2400 12000 25
6 3100 18600
7 2600
8 2900
9 3800
10 4500
11 4000
12 4900 58,800 144
Σx =78 Σy = 33,350 Σ xy =268,200 Σx2 = 650

268 ,200  (12 )( 6.5)( 2779 .17 )

b  359 .61 ; a  2779.17 - (359.61)(6 .5)  441.7
650  (12 )( 6.5) 2

a) The regression equation is –

y = a +bx = 441.7 + 359.61x ….. (Ans.)

b) Forecast for January next year, i.e. the next period is –

y13 = 441.7 + (359.61) (13) = 5116 units. … (Ans.)

Although, linear regression method is widely used in business, this is suitable for
demands of those products having more or less stable demand pattern. In case of rapid
and large-scale ups-downs, this is not suitable.

 Forecast Errors
There may be differences between actual sales and forecast amount. In statistics, these
variations are called “variance” or “Standard deviation”. While talking about Forecast
Error, we are referring to the difference between the forecast value and what actually
occurred.

It is necessary not only to forecast, but also to measure error for future adjustment,
and usefulness of a method.

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Dr. M. Ahsan Akhtar Hasin, IPE, BUET.

Forecast Error can be measured and understood in many ways:

1) Mean Absolute Deviation (MAD) – This is the most widely used error
measurement technique, although very simple. This measures the difference
between actual demand and forecast, without regard to sign (absolute value).
2) Mean Squared Error (MSE)
3) Tracking Signal (TS), etc.

MAD 
 At  Ft
, where n  no. of periods. ;
n
At = actual sales in period t; Ft – forecast demand for period t.

Weeks Demand/actual 3 week MA |At-Ft|

sales forecast
1 1200
2 1400
3 1000
4 1500 1200 300
5 1500 1300 200
6 1300 1333 33
7 1600 1433 167
8 1700 1467 233
9 1500 1533 33
Total Deviation 966

So, MAD = 966 / 6 =161 units

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