T3.

Forecasting approaches
Forecasting is the art and the science of predicting future events.
Because there are limits to what can be expected from forecasts, we develop error
measures.
Making good estimates is the purpose of forecasting.

Forecasting Time Horizons

1. Short-range forecast
▪ Up to 1 year, generally less than 3 months
▪ Purchasing, job scheduling, workforce levels, job
assignments, production levels
2. Medium-range forecast
▪ 3 months to 3 years
▪ Sales and production planning, budgeting
3. Long-range forecast
▪ 3+ years
▪ New product planning, facility location, research and
development
Distinguishing Differences
1. Medium/long-range forecasts deal with more comprehensive issues and
support management decisions regarding planning and products, plants
and processes
2. Short-term forecasting usually employs different methodologies than
longer-term forecasting
3. (example: moving averages, exponential smoothing, and trend
extrapolation)
4. Short-term forecasts tend to be more accurate than longer-term forecasts

Types of Forecasts
1. Economic forecasts
Address business cycle – inflation rate, money supply, housing starts, etc.
2. Technological forecasts
Predict the rate of technological progress
Impacts development of new products
3. Demand forecasts
Predict sales of existing products and services
Managers need demand-driven forecasts where the focus is on rapidly identifying
and tracking customer desires.
2 Forecasting approaches
• Qualitative methods: are subjective, based on the opinion and the
judgment of consumers and experts; they are only appropriate when past
data is not available.

• Quantitative methods: uses mathematical models and statistical

techniques to make predictions. It relies on historical data and
mathematical algorithms to project future values.

Differences between both methods

▪ QUALITATIVE METHODS
1. Executive opinion
Pool opinions of high-level experts.
2. Delphi method
Questioning a panel of experts individually to collect their opinions.
3. Salesforce estimate
Speaking with sales staff who work closely with customers and might have
thorough information about their satisfaction and experiences with the
company.
4. Market survey
Surveys ask customers of a business about their experience as a consumer.

▪ 2 DIFFERENT MODELS
1. Time-series models
Forecast based only on past values, no other variables are important.
Assumes that factors influencing past, and present will continue to
influence in future.
2. Associative model
Usually consider several variables that are related to the quantity being
predicted. Once these related variables have been found, a statistical
model is built and used to forecast the item of interest.
This approach is more powerful than the time-series methods that use only
the historical values for the forecast variable.

▪ QUANTITATIVE METHODS
 1. Naive method
Assume that demand in the next period will be equal to demand in the most
recent period.
2. Moving average method
Calculates the average demand for a product over a certain period and uses
it to estimate future demand. It is useful if we can assume that market
demands will stay fairly steady over time.
Weighted MA: puts more weight on recent data and less on past data. Past
data is weighted equally.
3. Exponential smoothing
Assign larger weights to more recent observations while assigning
exponentially decreasing weights as the observations get increasingly older.
4. Trend projection
Uses historical data and patterns to hypothesize and/or model how trends
will develop in the long-term or short-term future.
5. Linear regression
Imagine that sales of a PC depend on ads, competitors’ prices…
- Dependent variable: Sales of the PC.
- Independent variable: ads, competitor’s prices, and others.
Linear regression is used when changes in one or more independent
variables can be used to predict the changes in the dependent variable.

▪ ERRORS IN FORECAST AND TYPES

The overall accuracy of any forecasting model -moving average, exponential
smoothing, or other-, can be determined by comparing the forecasted
values with the actual or observed values.
Forecast error = Actual demand - Forecast value = At-Ft
1. Mean Absolute Deviation
Is the average distance between each data point and the mean. Take the
sum of the absolute values of the forecast error and dividing by the number
of periods.
2. Mean Squared Error
Measures how close a regression line is to a set of data points.
3. Mean Absolute Percent Error
Measures the average magnitude of error produced by a model, or how far
off predictions are on average.