FORECASTING

3
INTENDED LEARNING OUTCOMES

By the end of the learning experience, students must be able to:

1. Understand the meaning of forecasting;
2. Discuss and recognize the importance of forecasting to operations in organizations;
3. Explain and evaluate the strategic importance of forecasting to various organizations;
4. Classify and differentiate forecasting from planning;
5. List the types qualitative and quantitative forecasting, interpret its purpose in the
organizations and formulate evaluation tools for productive operations; and
6. Employ the forecasting process in real setting of business for valuable and productive
operations.

A. FORECASTING

Forecasts lie at the heart of Production and Operations Management (POM). They serve
as a key input to all POM decisions such as inventory management, production planning, and
scheduling as well as operations strategy and product innovation. All these decisions are based on
a forecast of the future, both long term at the strategic planning level as well as short-term
disaggregate forecasts used for tactical decisions. Improving forecasting performance has been
shown to lead to significant benefits in both POM and across the supply chain (Oliva and Watson
2011; Moritz et al. 2014).
However, implementation of forecasting processes and associated technologies is a
challenge. Methodological advancements, available technology, and information access have
elevated forecasting capability. In practice, however, forecasting processes still rely heavily on
human judgment (Lawrence et al. 2006). Forecasts within the practice of POM are usually
produced as a combination of statistical forecasts and judgment (Fildes and Goodwin 2007),
where an initial statistical forecast is adjusted judgmentally. Therefore, understanding forecasting
requires comprehending both statistical and judgmental methods, as well as ways they can be
combined in practice to improve performance.
Improving the practice of forecasting and extending relevant research requires
understanding methodological capabilities and their use but also current challenges and
shortcomings. In this chapter, we provide a state-of-the-art presentation of these critical issues.
We begin with an overview of the practice of forecasting by looking at its far reaching impact on
POM decisions and organizational costs, as well as its role in non-typical POM environments. We
then discuss the forecasting process and factors guiding method selection.
Forecasting is defined as the used of past data to determine future events: an objective
computation. Forecasting is the art and science of predicting what will happen in the future.
Sometimes that is determined by a mathematical method; sometimes it is based on the intuition
of the operations manager. Most forecasts and end decisions are a combination of both.

Importance of Forecasting to Operations

Forecasts are necessary for planning, scheduling, and controlling the system to facilitate
for effective and efficient output of goods and services. Forecasting is conducted by what are
referred to as time horizons.

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 1. Short Range Forecast: While it can be up to one year, this forecast is usually used for
three months or less. It is used for planning purchases, hiring, job assignments,
production levels, and the like.
2. Medium Range Forecast: This is generally three months to three years. Medium
range forecasts are used for sales and production planning, budgeting, and analysis of
different operating plans.
3. Long Range Forecast: Generally, three years or more in time span, it is used for new
products, capital expenditures, facility expansion, relocation, and research and
development.

Strategic Importance of Forecasts

Operations managers have two tools at their disposal by which to make decisions: actual
data and forecasts. The importance of forecasting cannot be underestimated. Take a product
forecast and the functions of human resources, capacity, and supply chain management. The
workforce is based on demand. This includes hiring, training, and lay-off of workers. If a large
demand is suddenly thrust upon the organization, training declines and the quality of the product
could suffer.
When the capacity cannot keep up to the demand, the result is undependable delivery,
loss of customers, and maybe loss of market share. Yet, excess capacity can skyrocket costs. Last
minute shipping means high cost. Asking for parts last minute can raise the cost. Most profit
margins are slim, which means either of those scenarios can wipe out a profit margin and have an
organization operating at cost -- or at a loss. These scenarios are why forecasting is important to
an organization. Good operations managers learn how to forecast, to trust the numbers, and to
trust their instincts to make the right decisions for their firm.
Forecasting System
These seven steps can generate forecasts.
1. Determine what the forecast is for.
2. Select the items for the forecast.
3. Select the time horizon.
4. Select the forecast model type.
5. Gather data to be input into the model.
6. Make the forecast.
7. Verify and implement the results.

Forecasting versus Planning

Forecasting is the process of predicting future events. This can range from forecasting
product demand, such as demand for the next iPhone, to forecasting the passage of a healthcare
bill in Congress. Any prediction of future events is a forecast.
Forecasting is one of the most important business activities because it drives all other
business decisions. Decisions such as which markets to pursue, which products to produce, how
much inventory to carry, and how many people to hire are all based on forecasts. Consider the full
range of POM decisions, from inventory ordering, production planning, scheduling, to project
management. They are all based on a forecast of demand.
In fact, the computations for order quantities and safety stocks contain a demand
component obtained through a forecast. These decisions are all part of the planning process often
confused with forecasting (Armstrong 2001). Planning is the process of selecting actions in
anticipation of a forecasted event. A forecast drives the plan that is made in response to the
forecast. As organizations attempt to decrease their statistical variability, they generate forecasts
and plan their resources accordingly.
Planning involves the following decisions:
• Scheduling Existing Resources: One important aspect of planning is deciding how to

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 best utilize existing resources. This includes decisions regarding product variety and
volumes produced transportation and deliveries at right locations, labor allocation
and utilization, facilities planning, and capital usage.
• Determining Future Resource Needs: Organizations must also determine what
resources will be needed in the future. These decisions depend on forecasts of
emerging markets, future customer demands, technological advancements, and
competition.
• Acquiring New Resources: It takes time to acquire new facilities, new technologies,
new equipment, and expand to new locations. Plans must be made well in advance,
and procedures to acquire new resources and capabilities put in place ahead of time.

Types of Forecasts
There are three major types of forecasting, regardless of time horizon, that are used by
organizations.
1. Economic Forecasts: Address the business cycle. They predict housing starts, inflation
rates, money supplies, and other indicators.
2. Technological Forecasts: Monitor rates of technological progress. This keeps
organizations abreast of trends and can result in exciting new products. New products
may require new facilities and equipment, which must be planned for in the appropriate
time frame.
3. Demand Forecasts: Deal with the company's products and estimate consumer demand.
These are also referred to as sales forecasts, which have multiple purposes. In addition to
driving scheduling, production, and capacity, they are also inputs to financial, personnel,
and marketing future plans.
• Dependent Demand: When the demand for one product is linked for the demand
of another item. Likewise, the products have relationship to one another or
functional products.
• Independent Demand: Demand for an item that occurs separately for the
demand of any item, other means the products has no viable relationship to the
other products.

Qualitative Forecasting Approaches

1. Executive Opinions. A small group of upper-level managers (e.g., in marketing,
operations, and finance) may meet and collectively develop a forecast. This approach is
often used as a part of long-range planning and new product development. It has the
advantage of bringing together the considerable knowledge and talents of various
managers. However, there is the risk that the view of one person will prevail, and the
possibility that diffusing responsibility for the forecast over the entire group may result in
less pressure to produce a good forecast.
2. Salesforce Opinions. Members of the sales staff or the customer service staff are often
good sources of information because of their direct contact with consumers. They are
often aware of any plans the customers may be considering for the future. There are,
however, several drawbacks to using salesforce opinions. One is that staff members may
be unable to distinguish between what customers would like to do and what they actually
will do. Another is that these people are sometimes overly influenced by recent
experiences. Thus, after several periods of low sales, their estimates may tend to become
pessimistic. After several periods of good sales, they may tend to be too optimistic. In
addition, if forecasts are used to establish sales quotas, there will be a conflict of interest
because it is to the salesperson’s advantage to provide low sales estimates.
3. Consumer Surveys. Because it is the consumers who ultimately determine demand, it

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 seems natural to solicit input from them. In some instances, every customer or potential
customer can be contacted. However, usually there are too many customers or there is no
way to identify all potential customers. Therefore, organizations seeking consumer input
usually resort to consumer surveys, which enable them to sample consumer opinions. The
obvious advantage of consumer surveys is that they can tap information that might not
be available elsewhere. On the other hand, a considerable amount of knowledge and skill
is required to construct a survey, administer it, and correctly interpret the results for valid
information. Surveys can be expensive and time-consuming. In addition, even under the
best conditions, surveys of the general public must contend with the possibility of
irrational behavior patterns.
4. Delphi method. It is an iterative process intended to achieve a consensus forecast. This
method involves circulating a series of questionnaires among individuals who possess the
knowledge and ability to contribute meaningfully. Responses are kept anonymous, which
tends to encourage honest responses and reduces the risk that one person’s opinion will
prevail. Each new questionnaire is developed using the information extracted from the
previous one, thus enlarging the scope of information on which participants can base their
judgments.

Quantitative Forecasting Approaches

1. Simple Moving Average: Average of demands occurring in several of the most recent
periods; most recent periods are added and old ones dropped to keep the calculations
current.

Formula: MA = Sum of demands for periods

Chosen number of periods

2. Weighted Moving Average: An averaging method that allows for varying weighting of old
demands. An advantage of this model is allows to compensate for some trend or
seasonality by carefully fitting the coefficients.

Formula: WMA = (old demand X weight) + (current demand X weight) + ……

3. Exponential Smoothing: An averaging method that exponentially decreases the

weighting of old demands, the pattern of weight is exponential in form. Demand for the
most recent period is weighted most heavily.

Table 3.1. Comparing Qualitative and Quantitative Methods

QUALITATIVE FORECASTING METHODS
STRENGTHS WEAKNESSES
Responsive to change Cannot process large data
Incorporates "soft" information Inconsistent
Compensates for unusual events Inability to process complexity
Biased (e.g., optimism, wishful thinking, political
Provides a sense of "ownership"
manipulation, lack of consistency)
QUANTITATIVE FORECASTING METHODS
STRENGTHS WEAKNESSES
Can process complexity Accuracy dependent on data and model

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 Objective Slow to respond to change
Consistent Costly to model "soft" information
Can process large data Requires technical understanding

Forecasting Process

Steps in the Forecasting Process

Forecasts need to be credible in order to be justified to other parties that include

management, suppliers, shareholders, and other stakeholders (Makridakis et al. 1983). To
ensure credibility the forecasting process needs to follow an established set of steps
regardless of what is being forecast or the model used (Armstrong 2001; Makridakis et al.
1982; Makridakis, Wheelwright, and Hyndman 2006). The steps are shown in Figure 3.2
and described below in the following sequence:
1. Decide what to forecast: Although seemingly simple, this initial step requires
thought. A forecast provides an answer to a question and formulating the right
question is critical. For example, there is an obvious difference between forecasting
sales (dollars) versus demand (units). A little less obvious may be a scenario where
company’s forecasts demand to better manage inventory levels but finds that
forecasting delivery lead times actually results in better performance. Forecasts are
made in order to develop plans for the future, and it is important to first identify what
forecasts are actually needed to develop them.
2. Analyze Data: Before we can forecast, we must analyze data in order to identify
patterns present and—as noted next—select the forecasting model most appropriate
for the identified pattern. The most commonly observed data patterns are:
• Level or Horizontal: This is the simplest pattern and exists when data
fluctuate around a constant mean. It is the easiest to predict and is
common for commodity products in the mature stage of the life cycle,
such as table salt or toothpaste.
• Trend: Trend is present when data exhibit an increasing or decreasing
pattern over time. The simplest type of trend is a straight line, or linear
trend, but a variety of trend patterns can exist such as exponential or
logarithmic.
• Seasonality: Seasonality is any pattern that regularly repeats itself. Most
intuitive are demand patterns that fluctuate with the seasons, such as sale
of ice cream or snow shovels. However, any pattern that regularly repeats
itself is a seasonal pattern, including holiday retail sales or end of the
month production rush.
• Cycles: Cycles are patterns created by economic fluctuations. Examples
include a recession, inflation, or even the life cycle of a product. The major
distinction between seasonal patterns and cycles is that the latter do not
have a repeating length or magnitude. As a result, they are most difficult
to predict.

In addition, data inherently contains a certain amount of random variation. The

greater the random variation, the harder it is to forecast as high degrees of
randomness can obscure the pattern. Forecasting focuses on identifying the patterns
in the data, attempting to smooth out the random variation, as shown below:
• Select the Forecasting Model: Once data patterns have been identified,
we can select an appropriate forecasting model that is suitable for the

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 identified data pattern. All models are not suited for every pattern.
Generally, two or three different forecasting models are selected, and
then they are tested on historical data to compare accuracy.
• Generate the Forecast: Once a model has been selected, the forecast is
generated. This can be through any number of software packages,
spreadsheets, or even via the use of paper and pencil.
• Measure Accuracy: After actual events have occurred, it is critical to
measure forecast accuracy, a step often overlooked. Measuring accuracy
provides information as to how well selected methods are performing
enabling process improvement. Data patterns change over time, and
models that once provided good results may no longer be adequate.

References

Anil Kumar, S and N. Suresh. (2009). Operations Management. New Age International (P) Ltd.,
Publishers. New Delhi. Retrieved from
http://182.160.97.198:8080/xmlui/bitstream/handle/123456789/436/Operations_Management%2
0-%20Kumar%20A%20A%20and%20Suresh%20N.pdf?sequence=1

Stevenson, W. J. (2012). Operations Management. 11th Edition. McGraw-Hill/Irwin. New York.

Retrieved from https://baixardoc.com/documents/operation-management-by-william-j-
stevenson-11th-edition-shuvo--5cf6d512051d3

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