International School of Business & Media

Forecasting
Productions Operations Management - I
Veeranna Bhusannavar
15063


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FORECASTING
Forecasting is the art and science of predicting future events. Until the last decade, forecasting
was largely an art, but it has now become a science as well. While managerial judgment is still
required for forecasting, managers today are aided by sophisticated mathematical tools and
methods. Forecasting has indeed come a long way from the black art of fortune-telling by use
of the stars, tea leaves, or crystal balls.
There is no universal forecasting method for all situations. Forecasts will almost always be
wrong. It is rare for sales to equal the exact amount forecast. A little variation from the forecast
can often be absorbed by extra capacity, inventory or rescheduling of orders.
There are three ways to accommodate forecasting errors. One is try to reduce the error
through better forecasting. The second is to build more flexibility into operations and supply
chain. The third is to reduce the lead time over which forecasts are required Even goods
forecasts will have some error, but the lowest possible error is the goal consistent with
reasonable forecasting costs.
Because of its complexity and its impact on business forecasting occupies a central role in the
firm.

FORECASTING TIME HORIZONS
A forecast is usually classified by the future time horizon that it covers. Time horizons fall into
three categories:
1. Short-range forecast. This forecast has a time span of up to 1 year but is generally less
than 3 months. It is used for planning purchasing, job scheduling, and workforce levels.
2. Medium-range forecast. A medium-range, or intermediate, forecast generally spans
from 3 months to 3 years. It is useful in sales planning, production planning and
budgeting, cash budgeting, and analyzing various operating plans.
3. Long-range forecast. Generally 3 years or more in time span, long-race for forecasts are
used in planning for new products, capital expenditures, facility location or expansion,
and research and development.

FORECASTING FRAMEWORK
There is a difference between forecasting and planning. Forecasting deals with what we think
will happen in future. Planning deals with what we think should happen in the future. Thus,
through planning, we consciously attempt to alter future events, while we use forecasting only
to predict them. Good planning utilizes a forecast as an input. If the forecast is not acceptable, a
plan can sometimes be devised to change the course of events.

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Forecasting is one input to all types of business planning and control, both inside and outside
the operations function. Marketing uses forecasts for planning products, promotion and pricing.
Finance uses forecasting as an input to financial planning. Forecasting is an input for operations
decisions on process design, capacity planning and inventory.
For process design purposes, forecasting is needed to decide on the type of process and the
degree of automation to be used. Since process decisions are long range in nature, they can
require forecasts for many years into the future.
Capacity design utilizes forecast at several different levels of aggregation and precision. For
planning the total capacity of facilities, a long-ranged forecast several years into the future is
needed. For medium-range-capacity decisions extending through the next year or so, a more
detailed forecast by product line will be needed to determine hiring plans, subcontracting, and
equipment decisions.
Inventory decisions resulting in purchasing actions tend to be short range in nature and deal
with specific products. The forecast that lead to these decisions must meet the same
requirements as short-range scheduling forecasts: They must have a high degree of accuracy
and individual product specificity. For Inventory and scheduling decisions, because of the many
items usually involved, it will also be necessary to produce a large number of forecasts. Thus, a
computerized forecasting system will often be used for these decisions.
Forecasting is used for many purposes in marketing, including sales planning, new-product
introduction, and design of marketing programs, pricing decisions, advertising, and distribution
planning. Forecasting isnt limited to one aspects of marketing; rather, it affects all marketing
decisions. In fact, forecasting responsibilities may sometimes be assigned to marketing or to a
cross-functional team consisting of marketing, operation, and financial personnel.
The finance, accounting, and human resources functions are also keenly interested in
forecasting. Even the routine task of making a budget or estimating costs requires a volume
forecast and financial plans grounded on forecasts of sales. Human resource requires a forecast
to anticipate hiring decisions and personnel budgets.
Hiring, training and laying off workers all depend on anticipated demand. If the human
resources department must hire additional workers without warning, the amount of training
declines and the quality of the workforce suffers. A large Lousiana chemical firm almost lost its
biggest customer when a quick expansion to around-the-clock shifts led to a total breakdown in
quality control on the second and third shifts.
Good supplier relations and the ensuring price advantages for materials and parts depend on
accurate forecasts.
Three types of forecasting methods associated with these decisions: qualitative, time series,
and casual.
In general terms, qualitative forecasting methods rely on managerial judgment; they do not use
specific models. Thus, different individuals can use the same qualitative method and arrive at

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widely different forecasts. Qualitative methods are useful, however, when there is a lack of
data or when past data are not reliable predictors of the future. In this case, the human
decision maker can utilize the best available data and a qualitative approach to arrive at a
forecast.
There are two types of quantitative forecasting methods: time-series and casual forecasting. In
general, quantitative methods utilize an underlying model to arrive at a forecast. The basic
assumption for all quantitative forecasting methods is the past data and data patterns are
reliable predictors of the future. Past data are then processed by a time-series or causal model
to arrive at a forecast.

TYPES OF FORECASTS
Organizations use three major types of forecasts in planning future operations:
1. Economic forecasts address the business cycle by predicting inflation rates, money
supplies, housing starts, and other planning indicators.
2. Technological forecasts are concerned with rates of technological progress, which can
result in the birth of exciting new products, requiring new plants and equipment.
3. Demand forecasts are projections of demand for a companys products or services.
These forecasts, also called sales forecasts, drive a companys production, capacity and
scheduling systems and serve as inputs to financial, marketing, and personnel planning.
Economical and technological forecasting are specialized techniques that may fall outside the
role of the operations manager. The emphasis in this book will therefore be on demand
forecasting.

TYPES QUALITATIVE FORECASTING METHODS
Qualitative forecasting methods utilize managerial judgment, experience, relevant data and an
implicit mathematical model. Qualitative forecasts should be used when past data are not
reliable indicators of future conditions. Qualitative forecasting must also be used for new-
product introductions, where a historical data is not available.
Nave approach
Moving averages
Exponential smoothing
Trend projection
Linear regression


Time-Series Models
Associative Models

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Time-Series Models
Time-series models predict on the assumption that the future is a function of past. In other
words, they look at what has happened over a period of time and use past weekly sales for
lawn mowers when making the forecasts.
Associative Models
Associative (or casual) models, such as linear regression, incorporate the variables or factors
that might influence the quantity being forecast. For example, and associative model for lawn
mower sales might include such factors as new housing starts, advertising budget and
competitors price.

SELECTING A FORECASTING METHODS
1. User and system sophistication: How sophisticated are the managers, inside and outside of
operations, who are expected to use the forecasting results? It has been found that forecasting
method must be matched to the knowledge and sophistication of the user. Generally speaking,
managers are reluctant to use results from techniques they do not understand.
Another related factor is the status of forecasting systems currently in use. Forecasting systems
tend to evolve toward more mathematically sophisticated methods; they do not change in one
grand step.
2. Time and resources available: The selection of a forecasting method will depend on the time
available in which to collect the data and prepare the forecast. This may involve the time of
users, forecasters, and data collectors. The preparation of a complicated forecast for which
most of the data must be located may take several months and costs thousands of dollars.
3. Use or decision characteristics: The forecasting method must be related to the use or a
decision required. The use, in turn, is closely related to such characteristics as accuracy
required, time horizon of the forecast, and number of items to be forecast.
4. Data Availability: The choice of forecasting method is often constrained by availability data.
An econometric model might require data that are simply not available in the short run;
therefore, another method must be selected. The quality of the data available is also a
concern. Poor data lead to poor forecasts. Data should be checked for extraneous factors or
unusual points.
5. Data Pattern: The pattern in the data will affect the type of forecasting method selected. If
the time series is flat, a first-order method can be used. However, if the data show trends or
seasonal patterns, more advanced methods will be needed. The pattern in the data will also
determine whether a time-series method will suffice or whether casual models are needed.
Thus, the data pattern is one of the most important factors affecting the selection of
forecasting method.

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FORECASTING IN THE SERVICE SECTOR
Forecasting in the service sector presents some unusual changes. A major technique in the
retail sector is tracking demand by maintaining good short-term records. For Instance, a
barbershop catering to men expects peak flows on Fridays and Saturdays. Indeed, most barber
shops are closed on Sunday and Monday, and many call in extra help on Friday and Saturday. A
downtown restaurant, on the other hand, may need to track conventions and holidays for
effective short-term forecasting.

COLLABORATIVE PLANNING, FORECASTING AND REPLENISHMENT
Collaborative planning, forecasting and replenishment (CPER) is a relatively new approach
aimed at achieving more accurate forecasts. The basic is to share information between
customers and suppliers in the supply chain during the planning a forecasting process.
Using CPER the customer and supplier exchange information on their respective forecasted
demands. When there is a discrepancy in the forecasts, a discussion ensures to discover the
basis for the difference. After discussion, an agreed forecast is developed that becomes the
basis for replenishment planning.
CPER is only useful in certain situations. It works best is BtoB relationships where there are only
a few customers that reflect the bulk of demand.

CONCLUSION
Forecasts are a critical part of the operations managers function. Demand forecasts drive a
firms production, capacity and scheduling systems and affect the financial, marketing, and
personnel planning functions.
There are a variety of qualitative and quantitative forecasting techniques. Qualitative
approaches employ judgment, experience, intuition, and a host of other factors that are
difficult to quantify. Quantitative forecasting use historical data, casual or associative relations
to project future demands.
No forecasting method is perfect under all conditions. And even once management has found a
satisfactory approach, it must still monitor and control forecasts to make sure errors do not get
out of hand. Forecasting can often be a very challenging, but rewarding, part of managing.



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EXAMPLES WHERE FORECASTING IS USED
Forecasting used in organization
Customers spending power: Finally, the firm cannot control its own markets. It may
Endeavour to do so by differentiating its products from other competing brands but in
broad terms it cannot determine how much money its potential customers have to
spend. Government policy will influence spending power through changes in both
taxation and interest rates.
Product development: The firm will obviously decide the products and services which it
will make. Its decisions will be influenced by its forecasts of markets and their potential.
The use of labor: Although pay rates are dictated by the local labor market, the firm is
not inhibited in the management of its workforce except insofar as regulations lay down
the boundaries for working hours and holidays and such items as a minimum wage. The
firm can plan recruitment and the training of its staff and make provision for pensions.
In forecasting its manpower requirements it will be necessary to take account of those
features of the business environment which will influence the growth of the firm and
timing of change.
Marketing: The business has complete control of its marketing and is able to promote
its products so as to optimize its sales revenue, taking into account the changes in the
level of the market in response to changes in the economic environment.
Long-term strategy and objectives: In planning long-term strategy it is necessary to take
into account all aspects of the business environment likely to bear on the firms
activities. Although strategic planning is an activity entirely within the firms control it is
nevertheless concerned with those factors outside its control. Planning must not be
carried out in a vacuum. It must make allowances for the timing and pattern of change
and for the action of competitors.
Ideally, the firm should agree its objectives. These are likely to include product
development, growth in sales, profit margins and return on capital. Having set the
objectives the plan should outline the ways and means of reaching those targets. This
will include the use of manpower, the generation of capital, investment to maintain and
increase capacity and efficiency, the provision of premises and the profile of costs.
In all these aspects of management, forecasting has a role to play and the following
chapters outline the approach and forecasting routines for the various subjects of
concern to the business.

USE OF FORECASTING IN DAY TO DAY LIFE
Unknowingly we forecast in our life at very point when we make a decision. The first thing we
do while taking a decision is think about various possibilities and its consequences. We make
that decision and ponder upon it because of our past experience which we must have had.