Forecasting

Forecasting Market Conditions

Unit HBC 2402 POM; BBIT/BCOM 4.2
CHARLES NTHIWA

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 Introduction
In simple terms, forecasting means, “estimation or prediction of
future”. The prediction of outcomes, trends, or expected future
behavior of a business, industry sector, or the economy through the use
of statistics. Forecasting is an operational research technique used as a
basis for management planning and decision making.

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Cntd
• Forecasting is a systematic guessing of the future course of
events.
• Forecasting provides a basis for a planning.
• According to Fayol, forecasting includes both assessing the
future and making provision for it.

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DEFINITION:

• Webster's new collegiate dictionary, “A forecast is a prediction

and its purpose is to calculate and predict some future events or
condition.”
• Allen L.A., “forecasting is a systemic attempt to probe the future
by inference from known facts.”
• Neter & Wasserman, “business forecasting refers to a statistical
analysis of the past and current movements in the given time
series so as to obtain clues about the future pattern of these
movement

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Features of forecasting

• It is concerned with future events.

• It is necessary for planning process.
• The impact of future events has to be considered in the planning
process.
• It is a guessing of future events.
• It considers all the factors which affect organizational functions.
• Personal observation also helps forecasting.

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Process of forecasting

1. Thorough preparation of foundation

• The very purpose of thorough preparation of a foundation is that the
forecasting is based on the foundation.
2. Estimation of future
• The brightness of future period can be estimated in consultation with
the key personnel & it may be communicated to all the employees of
the business unit.

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3. Collection of results
• Relevant records are prepared & maintained to collect the result.
4. Comparison of results
• The actual results are compared with estimated results to know
deviations. This will help the management to estimate the future.
5. Refining the forecast
• The forecast can be refined in the light of deviations which seem to be
more realistic.

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Importance of forecasting
1. Pivotal role in an organization:-
• Many organizations have failed because of lack of forecasting or faulty
forecasting. The reason is that planning is based on accurate
forecasting.
2. Development of a business:-
• The performance of specified objectives depends upon the proper
forecasting. So the development of a business or an organization is
fully based on the forecasting.

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3. Co-ordination:-
• Forecasting helps to collect the information about internal and
external factors. Thus collected information provides a basis for co-
ordination.
4. Effective control:-
• Management executive can ascertain the strength and weaknesses of
sub-ordinates or employees through forecasting.

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5. Key to success:-
• All business organizations are facing risks. Forecasting provides clues
and reduce risk and uncertainties. The management executives can
save the business and get success by taking appropriate section.
6. Implementation of project:-
• Many entrepreneurs implement a project on the basis of their
experience .Forecasting helps an entrepreneur to gain experience and
ensures him success.

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7. Primacy to planning:-
• The information required for planning is supplied by forecasting. So,
forecasting is the primacy to the planning.

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Advantages

• Effective handling of uncertainty

• Better labor relations
• Balanced work-load
• Minimization in the fluctuations of production
• Better use of production facilities

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• Better material management
• Better customer service
• Better utilization of capital and resources
• Better design of facilities and production system.

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Limitation

• Forecasting is to be made on the basis of certain assumptions and

human judgments which yield wrong result.
• It can not be considered as a scientific method for guessing future
events.
• It does not specify any concrete relationship between past and future
events.

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• It requires high degree of skill.
• It needs adequate reliable information so difficult to collect reliable
information.
• Heavy cost and time consuming.
• It can not be applied to a long period.

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TYPES OF FORECASTS

Organizations use three major types of forecasts in planning future operations.

1. Economic forecasts:
• It addresses the business cycle by predicting inflation rates, money suppliers, housing
starts, and other planning indicators.
2. Technological forecasts:
These are concerned with rates of technological progress, which can result in the birth
of exciting new products, requiring new plants and equipments.
3. Demand forecasts:
These are projections of demand for a company’s products or service. These are
forecasts , also called sales forecasts, drive a company’s production, capacity, and
scheduling systems and serve as inputs to financial, marketing, and personnel planning.

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Forecasting methods
There are mainly two methods:
1. Qualitative methods
2. Quantitative methods

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Quantitative forecasting
methods
Time Series Models
• Such models predict on the assumption that the future is a function
of the past. In other words , they look at what has happened over a
period of time and use a series of past data to make a forecast.
Types:
1) Moving Averages(Simple and Weighted)
• A moving average forecasts uses a number of historical actual data
values to generate a forecast. Moving averages are useful if we can
assume that market demands will stay fairly steady over time.

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Associative Models
• Such models usually consider several variables that are related to the
quantity being predicted. Once these related variables have been found
,a statistical model is build and used to forecast the item of interest,
e.g; the sales of Dell PCs may be related to the Dell’s advertising
budget, the company’s prices, competitor’s prices and promotional
strategies. In this case PCs sales would be called the dependent variable
and the other variables would be called the independent variables.
• Most common approach is Least Square Method or Linear-Regression
Analyses.

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Qualitative Forecasting
Methods
DELPHI METHOD - To overcome the limitation of above method, a committee is formed. A
moderator creates a questionnaire & distributes to the participants. The identity of committee
members is concealed. Their responses are summed up. A new set of questions is prepared.
Steps involved--
1. Choose experts to participate from different areas.
2. Their questionnaire or email obtain forecasts.
3. Summarize the results.
4. Redistribute results with another new questionnaire.
5. Summarizes again- refining forecasts.
6. Carry on 3 to 6 rounds
7. It results in forecasts that most participants have ultimately agreed to in
spite of their initial disagreement

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EDUCATED GUESS
• Judgment based on experience & intuition to estimate a sales forecast
(by one person)
• Used for short term forecast when cost of forecast inaccuracy is low.
• Such forecasts have to be made very frequently.
SURVEY OF CUSTOMERS
• Suitable when a company has few customers e.g. Automobile/defense
contractors. Estimates are gathered from customers directly.

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EXECUTIVE COMMITTEE CONSENSUS
•Forecast made by a committee of knowledge executive from different
departments. Such forecast are compromise forecast not reflecting the
extremes.
•People from a lower level may not speak freely to refute the estimates
of
people saving above them.

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SURVEY OF SALES FORCE
Used for existing product when salespeople sell directly to customers & a good
communication system exists in an organization.
Estimates of future regional sales are obtained from sales people. These are refined by
managers & total sales for all regions is estimated on its behalf.
MARKET RESEARCH
Suitable for new products or introduction of exiting product in new market segments.
Then mail, questionnaires, surveys, telephone interviews- hypothesis is tested
HISTORICAL ANALOGY
For a new product a generic or existing product is used as a model. The analogies may be
complementary product/substitutes. Knowledge of one product sales during various
stages of its product life cycle is applied to the estimate of sales for a similar product.

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Regression Analysis:-

• Regression analysis is used to find out the effect of changes of the

relative movements of two or more inter-related variables. In the
modern business conditions and situations ,number of factor are
responsible for the changes made in the variables.
• For example , if we take two inter related variables viz. cost of
production and profit ,there will be a direct relationship prevailing
between this two variables. It is possible to have an estimate of profit
on the basis of cost of production ,provided other things remain the
same.

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Examples of regression analysis

Y = a + bx
Use a linear regression model i.e
Y = β0 + β1X + β2X+ є

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Use Economic Order Quantities (EOQ)
Used as models for determining inventory management
• All models are classified into two major types:
(i) Deterministic Models, and
(ii) Probabilistic Models
• In brief, the deterministic models are built on the assumption that
there is no uncertainty associated with demand and replenishment of
inventories.

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cntd
• On the contrary, the probabilistic models take cognizance of the fact
that there is always some degree of uncertainty associated with the
demand pattern and lead time of inventories.
• Usually, the following three deterministic models are in use:
1. Economic Ordering Quantity (EOQ) Model,

2. ABC Analysis,

3. Inventory Turnover Ratio,

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(EOQ) model

• As the name suggests, Economic order quantity (EOQ) model is the method that
provides the company with an order quantity. This order quantity figure is where
the record holding costs and ordering costs are minimized. By using this model, the
companies can minimize the costs associated with the ordering and inventory
holding.
Definition
• The economic order quantity (EOQ) is a model that is
used to calculate the optimal quantity that can be
purchased or produced to minimize the cost of both
the carrying inventory and the processing of purchase
orders or production set-ups.
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assumption of the EOQ model

• The cost of the ordering remains constant.

• The demand rate for the year is known and evenly
spread throughout the year.
• The lead time is not fluctuating (lead time is the
latency time it takes a process to initiate and complete).
No cash or settlement discounts are available, and the
purchase price is constant for every item.
• The optimal plan is calculated for only one product.

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• There is no delay in the replenishment of the stock,
and the order is delivered in the quantity that was
demanded, i.e. in whole batch.

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The formula

EOQ = √ (2SD/H)

Holding Cost
Holding cost is the cost of a holding of inventory in storage. It is
the direct cost that needs to be calculated to find the best
opportunity whether to store inventory or instead of it invest it
somewhere else- assuming demand to be constant.

H = i*C

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Where
Q = optimal order quantity

• D = units of annual demand

• S = cost incurred to place a single order or setup

• H = carrying cost per unit

• This formula is derived from the following cost

function:

• Total cost = purchase cost + ordering cost +

holding cost

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• For example, consider a retail clothing shop that carries a line of
men’s shirts. The shop sells 1,000 shirts each year. It costs the
company $5 per year to hold a single shirt in inventory, and the fixed
cost to place an order is $2.

• The EOQ formula is the square root of (2 x 1,000 shirts x $2 order

cost) / ($5 holding cost), or 28.3 with rounding. The ideal order size to
minimize costs and meet customer demand is slightly more than 28
shirts.

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QUESTIONS:

Q1.) Define qualitative & quantitative forecasting

methods.
Q2.) Define forecast accuracy.
Q3.) Name three underlying reasons why operations
management must forecast.
Q4.) Describe how forecasting is integral to business
planning .
Q5.) Name the four components or data patterns of long range
demand in forecasting.
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