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MET463 Operations Management

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 Module III-Topics

1. Demand forecasting
2. Need and uses of forecasting
3. Components of forecasting demand
4. Time series methods
5. Moving average
6. Weighted moving average
7. Exponential smoothing
8. Adjusted exponential smoothing
9. Linear regression
10. Seasonal adjustments
11. Forecast accuracy

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 Demand forecasting

Demand forecasting is the method of accurate determination of

the demands of sales.
It estimates the quantity of production on the basis of forecasted
demand.
Purpose of sale forecasting
1. It determines the volume of production and the production rate.
2. It forms basis for production budget, labour budget, material
budget, etc.
3. It suggests the need for plant expansion.
4. It suggests the Downloaded
need for changes
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production methods.
 Demand forecasting
1. General business condition – General business conditions
include general economic condition of the country, population,
distribution of income and wealth in the country, general
traditions and customs, fashion, seasonal fluctuations, per
capita income, government policy, etc.
2. Conditions within the industry – Conditions within the
industry that should be considered include number of units
within the industry, design of product, quality of product,
price policy, product line of the enterprise, stage of
competition within the industry, expected improvements in
the product, etc.
3. Internal factors of the enterprise – These factors include
plant capacity of the enterprise, quality of the product, price
of the product, advertisement and distribution policies of the
enterprise, etc.
4. Factors affecting export trade – A business enterprise
engaged in export trade should consider the factors affecting
export trade such as import and export controls, terms and
conditions of export, international policy, etc.
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 Patterns in time series sales forecasting

1. Trends – Trends in a time series is a systematic increase or decrease

in the average of the series over time.
2. Cycles – Cycles are of shorter duration and they are usually featured
by alternate periods of expansion and contraction.
3. Seasonal variations – These occur within a certain period of year
and recur at about the same time and to approximately the same
extent from year to year.
4. Irregular variations – Irregular variations are the result of
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Demand forecasting methods

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Comparing qualitative and quantitative
methods

Qualitative methods Quantitative methods

This method is used when This method is used in stable

situation is vague and little situations where historical
data available. data is available.

Qualitative methods are used Quantitative methods are used

for new products. for existing products.

Mathematical techniques are

Quantitative methods involve
not used in qualitative
mathematical techniques.
methods.

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 Demand forecasting methods
1. Jury of executive opinion – The views of executives or experts from
sales, production, finance, purchasing, and administration are
averaged to generate a forecast about future sales as they are well
informed about the company’s market position, capabilities,
competition and market trend.
2. Delphi method – In this method, a panel of experts is asked to
respond to a series of questionnaires. The responses are tabulated
and opinions of the entire group are made known to each of the other
panel members so that they may revise their previous forecast
response. The process continues until some degree of consensus is
achieved.
3. Sales force opinion – Under this method, the salesmen estimate the
expected sales in their respective territories on the basis of previous
experience. Then demand is estimated after combining the individual
forecasts (sales estimates) of the salesmen.
4. Survey of customers buying – In this method, market surveys are
conducted regarding specific consumer purchases. Surveys may
consist of telephone contacts, personal interviews, or questionnaires
as a means of obtaining data. Extensive statistical analysis usually is
applied to survey results in orderfrom
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 Steps in quantitative demand forecasting
1. Identify the need for forecasting –The objects for which demand
forecasting are being made must be determined by the marketing
manager with the consultation of top management because it is the
most important step of the process.
2. Select the period of forecast – Next step in demand forecast is to
select the optimum period for which sale forecast is to be made.
3. Select the indicators relevant to the need – Depending upon the
product or product line, one or more of the following may be
identified.
a) Industry demand.
b) Competitors present and project capacity.
c) Economic development, etc.
4. Select the forecast model to be used
5. Data collection
6. Prepare forecast
7. Evaluate
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 Simple average technique
The simple arithmetic average of a set of observed values of
sales for n-period is calculated and it is used as forecast for the
(n+1)th period in the immediate future.

Forecast for ‘n+1’ period is Fn+1 =

Davg

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 ‘n’ period moving average method
A Moving Average (MA) is obtained by summing and averaging the
values from a given number of periods repetitively, each time deleting
the oldest value and adding a new value.
The number of period selected for moving average depends on what is
forecasted and characteristics of demand.
The forecasting equation will be of the form as below.

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 Weighted moving average
In this method, different weights are given to different periods as
compared to simple moving average where equal weights are given
to all the periods.
The forecasting equation will be of the form as below.

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Problems:
1. The monthly sales of scooters in an automobile shop are given
below for one year. Find the sales forecast for the next month using,
a) Simple average method b) Three months, four months and five
months moving average c) Calculate weighted moving average for
the 13th month taking weightages as 0.1, 0.1, 0.2, 0.2, 0.3 and 0.1 for
the 7 th month to 12th month respectively.
Mont
1 2 3 4 5 6 7 8 9 10 11 12
h
Sales 12 18 24 28 36 30 21 42 15 8 20 10

Solution
:

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Problems:
b) Forecast for the next month using three, four and five month
moving average is computed and is tabulated in the table below.

Month Sales 3 Months MA 4 months MA 5 months MA

1 12.00 - - -
2 18.00 - - -
3 24.00 - - -
4 28.00 18.00 - -
5 36.00 23.33 20.50 -
6 30.00 29.33 26.50 23.60
7 21.00 31.33 29.50 27.20
8 42.00 29.00 28.75 27.80
9 15.00 31.00 32.25 31.40
10 8.00 26.00 27.00 28.80
11 20.00 21.67 21.50 23.20
12 10.00 14.33 21.25 21.20
13 12.67 13.25 19.00

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 Problems:
c
)

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 Exponential smoothing
In simple exponential smoothening, the forecast F n+1 is made up of
the last period forecast F n plus a portion, ‘α’ multiplied by the
difference between the last periods actual demand An and last
period forecast F n and is given by the equation given below.

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Problems :
1. A firm uses simple exponential smoothing with α = 0.1 to forecast
demand. The forecast for the week of February was 500 units,
whereas actual demand was 450 units. a) Forecast the demand
for the next week. b) Continue forecasting through assuming that
subsequent demands were 505, 516, 488, 467, 554 and 510 units.
Solution
:

Given forecast for the first week of February as 500 units and
actual demand as 450 units. Forecast for the next time period
are tabulated below.

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Problems :
Solution
:
Given forecast for the first week of February as 500 units and
actual demand as 450 units. Forecast for the next time period
are tabulated below.
Fn An

500 450 F 2 = 500 + 0.1(450 - 500) = 495

495 505 F 3 = 495 + 0.1(505 - 495) = 496
496 516 F 4 = 496 + 0.1(516 - 496) = 498
498 488 F 5 = 498 + 0.1(488 - 498) = 497
497 467 F 6 = 497 + 0.1(467 - 497) = 494
494 554 F 7 = 494 + 0.1(554 - 494) = 500
500 510 F 8 = 500 + 0.1(510 - 500) = 501

Forecast for the 8th week is 501

units.

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 Adjusted exponential
smoothing
Simple exponential smoothing forecast may be adjusted for
significant trend effects by adding a trend smoothing factor to the
calculated forecast value.

Forecast Including Trend, FIT is hence calculated using the following

expression.

;where,
FIT n+1 = Adjusted Forecast Including
Trend
Fn+1 = Exponentially smoothed
forecast
Tn+1 = Trend estimate
α = Smoothing constant
β = Trend smoothing constant

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 Problems:
1. Compute the adjusted exponential forecast for the first week of March for a firm with the
following data. Assume the forecast for the first week of January as 600 and corresponding
initial trend as 0. Take α = 0.1, and β = 0.2.

Week 1/1 2/1 3/1 4/1 1/2 2/2 3/2 4/2

Deman
650 600 550 650 625 675 700 710
d

Solution
:
We have, Forecasting Including
Trend,

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 Problems:

Trend adjustment factor for the 2nd week of

January =

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 Problems:

The leftover calculations are given in

table below.
Week Fn An Fn+1 Tn Tn+1 FIT n+1

2 600 650 605.0 0.0 1.00 606.00

3 605.0 600 605.4 1.0 0.880 606.28

4 605.4 550 600.7 0.9 -0.246 600.41

5 600.7 650 605.4 -0.2 0.746 606.11

6 605.4 625 608.0 0.7 1.124 609.12

7 608.0 675 615.7 1.1 2.442 618.15

8 615.7 700 626.3 2.4 4.078 630.42

9 626.3 710 638.4 4.1 5.670 644.05

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 Regression analysis
Regression means dependence and involves estimating the value of a
dependent variable y from an independent variable x.
Regression techniques used in demand forecasting are : -
1. Least square method
2. Logarithmic straight
3. Parabolic method

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Least square method/ Linear regression
method
A straight line fitted in the least square method is given as,

; where,
y = The dependent variable (regressed forecast) of
sales in
rupees or volume of demand,
x = The independent variable in terms of unit of
time as day,
week, month or year.
‘a’ and ‘b’ = The values of the constant.
They are determined by the two simultaneous
equations.

The values of ‘a’ and ‘b’ can be calculated by the following

equations.

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 Least square method/ Linear regression
method
Least square method when the sum of the deviations is not zero.
For the straight line, y = a + bx, the constants ‘a’ and ‘b’ can be
computed by solving the following the expression.

Alternatively the values of the constant ‘a’ and ‘b’ can be computed
by solving the two equations.

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Problems:
1. From the following time series data of sale project the sales for the next
three years.
200 200 200 200 200
Year x 2001 2003
2 4 5 6 7
Sale (1000
y 80 90 92 83 94 99 92
unit)

Solution
:

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Problems:

Product of
Time Sales in
Squares of time
deviation (1000
Years time deviations
from 2004 units)
and sales

(x) (y) (x²) (xy)

2001 –3 80 9 –240
2002 –2 90 4 –180
2003 –1 92 1 –92
2004 0 83 0 0
2005 +1 94 1 +94
2006 +2 99 4 +198
2007 +3 92 9 +276
N=7 Σx = 0 Σy = 630 Σx² = 28 Σxy = + 56

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 Problems:
To find the values of a
and b,

Hence regression equation takes the form, y = 90 + 2x. With the help
of this equation we can project the trend values for the next 3 years.

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Problems:
2. An investigation into the demand for colour TV sets in 5 towns has
resulted in the following data:
Population of the town (in
x 5 7 8 11 14
lakhs)
No of TV sets demanded (in
y 9 13 11 15 19
thousands)

Fit a linear regression of y on x and estimate the demand for CTV

sets for two towns with a population of 10 lakhs.
Solution
:

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Problems:

Sales of CTV Squares of Product of

Population
(in the population and sales
(in lakhs)
thousands) population of color TV

(x) (y) (x²) (xy)

5 9 25 45
7 13 49 91
8 11 64 88
11 15 121 165
14 19 196 266
Σx = 45 Σy = 67 Σx² = 455 Σxy = 655

To find the values of a and b, the following two equations are to be

solved.

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 Problems:
Solving these equations we get, a = 4.04 and b = 1.04.

Now by putting the values of a, b and x (10 lakhs) in regression

equation, we get,

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 Seasonal adjustments

A seasonal pattern is a repetitive increase and decrease in demand.

Many demand items exhibit seasonal behavior.
One method for developing a demand for seasonal factors is to
divide the demand for each seasonal period by total annual demand,
according to the following formula.

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 Forecast accuracy measures
All forecasts certainly contain some error.
Two main methods are used in this regard are discussed below.

1. Mean Absolute Deviation (MAD) – This is computed by

taking the sum of the absolute values of the individual
forecast errors and dividing by the number of periods of
data (n).

2. Mean Squared Error (MSE) – MSE is the average of the

squared differences between the forecasted and observed
values which can be expressed as below.

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