CHAPTER 2

FORECASTING
 WHAT IS FORECAST?

• FORECASTS ARE A BASIC INPUT IN

THE DECISION PROCESSES OF
OPERATIONS MANAGEMENT BECAUSE
THEY PROVIDE INFORMATION ON
FUTURE DEMAND.
• ANTICIPATED DEMAND IS DERIVED
FROM TWO POSSIBLE SOURCES.

1.ACTUAL CUSTOMER ORDERS

2.FORECASTS
TWO ASPECTS OF FORECASTS

1.Expected level of demand – can be

function a function of some structural
variation, such as trend or seasonal
variation.
2.Forecast accuracy – is a function of the
ability of forecasters to correctly model
demand, random variation, and sometimes
unforeseen events.
• A TIME HORIZON, ALSO KNOWN AS A PLANNING HORIZON, IS A
FIXED POINT OF TIME IN THE FUTURE AT WHICH POINT
CERTAIN PROCESSES WILL BE EVALUATED OR ASSUMED TO
END
• SHORT-TERM FORECASTS PERTAIN TO ONGOING
OPERATIONS.
• LONG-TERM FORECASTS PERTAIN TO NEW PRODUCTS OR
SERVICES, NEW EQUIPMENT, NEW FACILITIES, OR SOMETHING
ELSE THAT WILL REQUIRE A SOMEWHAT LONG LEAD TIME TO
DEVELOP, CONSTRUCT, OR OTHER OTHERWISE IMPLEMENT.
 Here are the examples of uses of
forecasts in business organizations

ACCOUNTING – NEW PRODUCT/PROCESS

COST ESTIMATES, PROFIT PROJECTIONS, CASH
MANAGEMENT.
FINANCE – EQUIPMENT/EQUIPMENT
REPLACEMENT NEEDS, TIMING AND AMOUNT OF
FUNDING/BORROWING NEEDS.
HUMAN RESOURCES – HIRING ACTIVITIES,
INCLUDING RECRUITMENT, INTERVIEWING, AND
TRAINING; LAYOFF PLANNING, INCLUDING
OUTPLACEMENT COUNSELLING.
 HERE ARE THE EXAMPLES OF USES OF
FORECASTS IN BUSINESS ORGANIZATIONS

 MARKETING – PRICING AND PROMOTION, E-BUSINESS

STRATEGIES, GLOBAL COMPETITION STRATEGIES.
 MIS – NEW/REVISED INFORMATION SYSTEMS, INTERNET
SERVICES.
 OPERATIONS – SCHEDULES, CAPACITY PLANNING, WORK
ASSIGNMENTS AND WORKLOADS, INVENTORY
PLANNING, MAKE-OR-BUY DECISIONS, OUTSOURCING,
PROJECT MANAGEMENT.
 PRODUCT/SERVICE DESIGN – REVISION OF CURRENT
FEATURES, DESIGN OF NEW PRODUCTS OR SERVICES.
 TWO USES FOR FORECASTS

1. PLANNING THE SYSTEM – GENERALLY INVOLVES

LONG-RANGE PLANS ABOUT THE TYPES OF
PRODUCTS AND SERVICES TO OFFER, WHAT
FACILITIES AND EQUIPMENT TO HAVE, WHERE TO
LOCATE AND SO ON.
2. PLANNING THE USE OF THE SYSTEM – REFERS TO
SHORT-RANGE AND INTERMEDIATE-RANGE PLANNING,
WHICH INVOLVES TASKS SUCH AS PLANNING
INVENTORY AND WORKFORCE LEVELS, PLANNING
PURCHASING AND PRODUCTION, BUDGETING, AND
SCHEDULING.
ELEMENTS OF A GOOD FORECAST
 TIMELY - THE HORIZON MUST COVER THE TIME
NECESSARY TO IMPLEMENT CHANGES SO THAT ITS
RESULTS CAN BE USED.
 ACCURATE - THE DEGREE OF ACCURACY SHOULD
BE STATED, ENABLING USERS TO PLAN FOR
POSSIBLE ERRORS AND PROVIDING A BASIS FOR
COMPARING ALTERNATIVE FORECASTS.
 RELIABLE METHODS - METHOD/SOFTWARE SHOULD
WORK CONSISTENTLY
ELEMENTS OF A GOOD FORECAST
 MEANINGFUL UNITS - CHOICES OF UNITS SHOULD
BE DEPENDENT ON USER NEEDS
 RESULTS IN WRITING - THE FORECASTS USERS
MUST ALL BE ON THE SAME PAGE, SO ALL SHOULD
BE READING FROM A WRITTEN SUMMARY OF
FORECAST RESULTS (SAME INTERPRETATION)
 SIMPLE TECHNIQUES - THE TECHNIQUE SHOULD BE
EASY TO USE, AND SIMPLE TO UNDERSTAND. IF THE
TECHNIQUE IS TOO SOPHISTICATED, USERS MAY
NOT HAVE FAITH IN IT.
ELEMENTS OF A GOOD FORECAST

 COST-EFFECTIVE - THE FORECAST'S COST OF

IMPLEMENTATION SHOULD BE JUSTIFIED /
OUTWEIGHED BY ITS BENEFITS.
 STEPS IN THE FORECASTING PROCESS

 DETERMINE THE PURPOSE OF THE FORECAST – THIS STEP WILL

PROVIDE AN INDICATION OF THE LEVEL OF DETAIL REQUIRED IN
THE FORECAST, THE AMOUNT OF THE RESOURCES (PERSONNEL,
COMPUTER TIME, DOLLARS) THAT CAN BE JUSTIFIED, AND LEVEL
OF ACCURACY NECESSARY.
 ESTABLISH A TIME HORIZON – THE FORECAST MUST INDICATE A
TIME INTERVAL, KEEPING IN MIND THAT ACCURACY DECREASES
AS THE TIME HORIZON INCREASES.
 OBTAIN, CLEAN, AND ANALYZE APPROPRIATE DATA – OBTAINING
THE DATA CAN INVOLVE SIGNIFICANT EFFORT. ONCE OBTAINED,
THE DATA MAY NEED TO BE “CLEANED” TO GET RID OF OUTLIERS
AND OBVIOUSLY INCORRECT DATA BEFORE ANALYSIS.
 STEPS IN THE FORECASTING PROCESS

SELECT A FORECASTING TECHNIQUE.

MAKE THE FORECAST.
MONITOR THE FORECAST ERRORS – THE FORECAST
ERRORS SHOULD BE MONITORED TO DETERMINE IF
THE FORECAST IS PERFORMING IN A SATISFACTORY
MANNER.
 TWO PREDOMINANT APPROACHES TO
FORECASTING

1.QUALITATIVE APPROACH - A QUALITATIVE

APPROACH USES FACTORS SUCH AS EXPERIENCE,
INSTINCT AND EMOTION.

2.QUANTITATIVE APPROACH - THE QUANTITATIVE

ANALYSIS RELIES HEAVILY ON MATHEMATICS,
HISTORICAL DATA AND CASUAL VARIABLES.
 THE FOLLOWING PRESENT A VARIETY OF
FORECASTING TECHNIQUES THAT ARE
CLASSIFIED AS:
• JUDGMENTAL FORECAST - RELY ON ANALYSIS OF
SUBJECTIVE INPUTS OBTAINED FROM VARIOUS
SOURCES, SUCH AS CONSUMER SURVEYS, THE SALES
STAFF, MANAGERS AND EXECUTIVES, AND PANELS OF
EXPERTS.
• TIME-SERIES FORECASTS – SIMPLY ATTEMPT TO
PROJECT PAST EXPERIENCE INTO THE FUTURE. THESE
TECHNIQUES USE HISTORICAL DATA WITH THE
ASSUMPTION THAT THE FUTURE WILL BE LIKE THE PAST.
• ASSOCIATIVE MODELS – USE EQUATIONS THAT
CONSISTS OF ONE MORE EXPLANATORY VARIABLES
THAT CAN BE USED TO PREDICT DEMAND.
•THESE BEHAVIORS CAN BE DESCRIBED AS FOLLOWS:
TREND – REFERS TO A LONG-TERM UPWARD OR
DOWNWARD MOVEMENT IN THE DATA. POPULATIONS
SHIFTS, CHANGING INCOMES, AND CULTURAL CHANGES
OFTEN ACCOUNT FOR SUCH MOVEMENTS.
 SEASONALITY – REFERS TO SHORT-TERM, FAIRLY
REGULAR VARIATIONS GENERALLY RELATED TO FACTORS
SUCH AS THE CALENDAR OR TIME OF DAY. RESTAURANTS,
SUPERMARKETS, AND THEATER EXPERIENCE WEEKLY AND
EVEN DAILY “SEASONAL” VARIATIONS.

•THESE BEHAVIORS CAN BE DESCRIBED AS FOLLOWS:
CYCLES – ARE WAVELIKE VARIATIONS OF MORE THAN ONE YEAR’S
DURATION. THESE ARE OFTEN RELATED TO A VARIETY OF
ECONOMIC, POLITICAL, AND EVEN AGRICULTURAL CONDITIONS.
IRREGULAR VARIATIONS – ARE DUE TO UNUSUAL
CIRCUMSTANCES SUCH AS SEVERE WEATHER CONDITIONS,
STRIKES, OR A MAJOR CHANGE IN A PRODUCT OR SERVICE.
RANDOM VARIATIONS – ARE RESIDUAL VARIATIONS THAT REMAIN
AFTER ALL OTHER BEHAVIORS HAVE BEEN ACCOUNTED FOR.
 FORECASTING METHODS
FOCUS FORECASTING – USING THE FORECASTING METHOD
THAT DEMONSTRATES THE BEST RECENT SUCCESS. THE
METHOD THAT HAS THE HIGHEST ACCURACY IS THEN USED TO
MAKE THE FORECAST OF THE NEXT MONTH. THIS PROCESS IS
USED FOR EACH PRODUCT OR SERVICE, AND IS REPEATED
MONTHLY.
DIFFUSION MODELS – WHEN NEW PRODUCTS OR SERVICES ARE
INTRODUCING, HISTORICAL DATA ARE NOT GENERALLY
AVAILABLE ON WHICH TO BASE FORECASTS. INSTEAD,
PREDICTIONS ARE BASED ON RATES OF PRODUCT ADOPTION
AND USAGE SPREAD FROM ESTABLISHED PRODUCTS, USING
MATHEMATICAL DIFFUSION MODELS.
•