Chapter 6

Need and Importance of Forecasting

Need and Importance of Forecasting Introduction 2. Concept of forecasting 3. Need of forecasting in POM 4. General steps in the forecasting 5. Importance and application of forecast in POM
1.

Forecasting

Introduction

Operations Strategy & Competitiveness Quality Management Strategic Decisions Design of Products and Services Process Selection and Design Capacity and Facility Decisions

Forecasting

Tactical & Operational Decisions

Forecasting

Predict the next number in the pattern:

3.7, 3.7, 3.7, 3.7, ?

a) 3.7,

b) 2.5,

4.5,

6.5,

8.5,

10.5,

c) 5.0, 7.5, 6.0, 4.5, 7.0, 5.5, 4.0, 6.5, ?

Forecasting

Predict the next number in the pattern:

3.7, 3.7, 3.7, 3.7, 3.7

a) 3.7,

b) 2.5,

4.5,

6.5,

8.5,

10.5, 12.5

c) 5.0, 7.5, 6.0, 4.5, 7.0, 5.5, 4.0, 6.5, 5.0

+2.5 -1.5 -1.5 +2.5 -1.5 -1.5 +2.5 -1.5

Need and Importance of Forecasting

Introduction 1. Individual interest to know about future. 2. To develop plan and implement to contingencies. 3. The effectiveness of plan depends upon the level of accuracy regarding future event knowledge. 4. Op manager try to FORECAST future to best of his
Ability Judgment Experience

Need and Importance of Forecasting

Concept of Forecast
Forecasting 1. The process of estimating a future event by casting forward past data. 2. Past data is systematically combined in predetermined way to obtain the estimate of future. 3. Forecast is an estimate of future values of certain specific indicators relating to decision / planning situation. 4. Single or multiple indicators are essential for forecasting. 5. Number of indicators and degree of detail depends upon the intended use of forecast.

Need and Importance of Forecasting

Forecasts rarely perfect because of randomness Forecasts more accurate for groups vs. individuals Forecast accuracy decreases as time horizon increases
Accounting Finance Human Resources Marketing Cost/profit estimates Cash flow and funding Hiring/recruiting/training Pricing, promotion, strategy

MIS
Operations Product/service design

IT/MIS systems, services

Schedules, MRP, workloads New products and services

Elements of Good Forecasting

Timely

Reliable

Accurate

Written

Need and Importance of Forecasting

Concept of Forecast
Strategic decision (1-5 year) Product design & mix Facility location & capacity Process design & Technology Aggregate planning (3-12 months horizon) Workforce size work shifts. Aggregate production, Planning over time, subcontracting, demand modification Short term planning (1-90 days horizon) Personnel scheduling and sequencing, Material purchasing

Need and Importance of Forecasting

Need of Forecast in POM
1. Purpose 2. Time Purpose 1. Future conditions offer a Purpose / Target to be achieved. 2. Purpose is to take advantage of or to minimize the impact of future conditions (If adverse) Example: Plan to set up additional plant to increase production capacity.
a). Estimate the future demand supply gap. b). Calculate the production target to take advantage of future demand supply. c). Prepare action plan and implement

4. Time factor is important.

Need and Importance of Forecasting

Need of Forecast in OM
1. Purpose 2. Time Time 1. Time is a resource 2. Organize resources to implement plan 3. Planning and implementation is required INTIME.

Need and Importance of Forecasting

Need of Forecast in OM
1. Purpose 2. Time Example: (Take advantage of future demand supply gap) 1. T1= Time taken to finalize the alternative as set up and additional plant 2. T2= Location of additional plant chosen 3. T3= Technology negotiation, Finance provision, land purchase activities, Legal obligations consideration, 4. T4= Construction, erecting testing, commercial production 5. T (Minimum time to plan and implement)= T1+T2+T3+T4

General steps in the forecasting process.

The forecast The forecast
Step 7 Monitor the forecast Step 6 Prepare forecast Step 5 Data collection Step 4 Select the forecast model Step 3 Select the indicator relevant to the need Step 2 Establish a time horizon Step 1 Determine purpose of forecast

Application

Indicators

Time span

New plant for Long term demand, long production term production capacity expansion of all producers.

5 or more years or some time less

Need and Importance of Forecasting

General steps in the forecasting process. Step-1: Identify the general need. (Purpose) Unfulfilled demand Need to expand production Decision required as how much and when? Step:2 Establish the time horizon Time estimate to erecting of new plant Forecast cover a period of 5 years including the erection period of 3 years.

Need and Importance of Forecasting

General steps in the forecasting process. Step-3: Select indicator relevant to the need. Indicators identified as per product and process Industry sales Competitors present and projected capacity Population projection Income level Economic development Step:4 Select the forecast model to be used. Model must be reliable and selection depends upon the type of data.

Need and Importance of Forecasting

General steps in the forecasting process. Step-5: Data Collection Data relevant to various indicators from appropriate source. Relevant data must be accurate. Data availability must be in time. Data must be sufficient. Step-6: Prepare Forecast Apply model using the data collected and calculate the value of the forecast.

Need and Importance of Forecasting

General steps in the forecasting process. Step-7: Monitor the forecast and Evaluate All models have methods of calculating upper and lower value in which the given forecast is expected to remain with certain level of probability. Evaluation can also be performed from logical point of view whether the value obtained is logically feasible?

Need and Importance of Forecasting

Importance and Application of forecasting in OM.

Forecast enables Op manager to take better action regarding future. Enables Op manager to discharge their function more effectively. Op Manager is better informed to set up objective more clearly. Thinking, alternative generation and selection becomes more focused. Organize and implement his action with time line.

Need and Importance of Forecasting

Importance and Application of forecasting in OM. For smaller error we have to use most sophisticated model of forecasting. Cost of model development, forecasting and maintaining trends are high. There must be trade off between choice of model and the cost.

Need and Importance of Forecasting

Importance and Application of forecasting in OM.

Forecast Importance directly proportional to (Result of action based on forecast) (Result of an action for the same situation without any forecast) If the difference is positive and large then importance is more otherwise not important. Forecast Error = (value forecast-value actually happened) For smaller error we have to use most sophisticated model of forecasting.

Need and Importance of Forecasting

Importance &Application of forecasting in OM.
Application New plant for production expansion Seasonal production planning Capital Planning Intermediate Op Planning Short term production adjustment Scheduling production Product development Indicators Long term demand, long term production capacity of all producers. Demand cycle from one to other peak Long term money market trends, interest rate trends Intermediate demand and shift in preferences Short term demand and short term material/input Order position, emergency orders Long term sales trend technological development in related fields Time span 5 or more years or some time less 6 months or pre defined. One or more years Upto about two years About six weeks One week Two years or more

Methods of Forecasting
All forecasting methods can be divided into two broad categories: Qualitative

Quantitative.
Division of forecasting methods into qualitative and quantitative categories is based on the availability of historical time series data. Many forecasting techniques use past or historical data in the form of time series. A time series is simply a set of observations measured at successive points in time or over successive periods of time.

Methods of Forecasting
All forecasting methods can be divided into two broad categories: Qualitative A key advantage of these procedures is that they can be applied in situations where historical data are simply not available. And if historical data are available, significant changes in environmental conditions affecting the relevant time series may make the use of past data irrelevant and questionable in forecasting future values of the time series.

Qualitative Forecasting Methods

Qualitative Forecasting

Executive Judgement

Sales Force Composite

Market Research/ Survey

Models Delphi Method

Qualitative Methods
Briefly, the qualitative methods are: Executive Judgment: Opinion of a group of high level experts or managers is pooled. Sales Force Composite: Each regional salesperson provides his/her sales estimates. Those forecasts are then reviewed to make sure they are realistic. All regional forecasts are then pooled at the district and national levels to obtain an overall forecast. Market Research/Survey: Solicit input from customers pertaining to their future purchasing plans. It involves the use of questionnaires, consumer panels and tests of new products and services.

Qualitative Methods
Delphi Method:
As opposed to regular panels where the individuals involved are in direct communication, this method eliminates the effects of group potential dominance of the most vocal members. The group involves individuals from inside as well as outside the organization.
Typically, the procedure consists of the following steps: Each expert in the group makes his/her own forecasts in form of statements The coordinator collects all group statements and summarizes them The coordinator provides this summary and gives another set of questions to each group member including feedback as to the input of other experts. The above steps are repeated until a consensus is reached.

Quantitative Forecasting Methods

Quantitative Forecasting

Time Series Models

Regression Models

1. Naive

2. Moving Average a) simple b) weighted

3. Exponential Smoothing a) level b) trend c) seasonality

Quantitative Methods of Forecasting

Time Series Models: Naive Approach Moving Average Exponential Smoothing Naive Approach A forecasting technique that assumes demand in the next period is equal to the demand in the most recent period. Cost effective- efficient forecasting model but is just starting point to follow most sophisticated model.

Quantitative Methods of Forecasting

Native Approach

Example-1; The sale of a product is 100 units in Nov-13. What is the sales forecast of this product in Dec-13?
Solution; The sales forecast for the month of Dec-13 will be 100 units of product.

Quantitative Methods of Forecasting

Moving Average To generate a forecast number of historical actual data values are used. It is based upon the assumption that the market demand will stay fairly steady over time. Moving Average= Sum of demand in previous n periods n i.e. ( no of period in moving average.

Quantitative Methods of Forecasting

Moving Average : Example-2:
Month Jan-10 Actual Sales 10 3 months Moving Average

Feb-10
Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10

12
13 16 19 23 26 30 28 18 (10+12+13)/3= 11.66

Nov-10
Dec-10

16
14

Calculate the forecast for Jan-11 on 3 months moving average?

Quantitative Methods of Forecasting

Moving Average : Example-2:
Month Jan-10 Actual Sales 10 3 months Moving Average

Feb-10
Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10

12
13 16 19 23 26 30 28 18 (10+12+13)/3= 11.66 (12+13+16)/3= 13.66 (13+16+19)/3= 16 (16+19+23)/3= 19.33 (19+23+26)/3= 22.66 (23+26+30)/3= 26.33 (26+30+28)/3= 28

Nov-10
Dec-10

16
14

(30+28+18)/3= 25.33
(28+18+16)/3= 20.66

Calculate the forecast for Jan-11 on 3 months moving average?

Quantitative Methods of Forecasting

Moving Average :
Weighted Moving Average: Example: Consider the actual sales of past example with the weight applied as given below

Weight Applied
3 2 1
________

Period
Last month Two months ago Three months ago

6 Forecast = (3x sales of last month + 2x sales 2 months ago+1x sales 3 months ago) / 6 i.e Sum of weight

Quantitative Methods of Forecasting

Moving Average :
Weighted Moving average: Example-3: Find the forecast if the wightage is 3 for most recent month, 2 for one month before most recent month and 1 for two month before most recent month.

Month Jan-10 Feb-10 Mar-10 Apr-10

Actual Sales 10 12 13 16

3 months weighted Moving Average

(3x13+2x12+10x1)/6= 12.16

May-10
Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10

19
23 26 30 28 18 16 14

(3x16+2x13+1x12)/6= 14.33

(3x16+2x18+1x28)/6= 18.66

Quantitative Methods of Forecasting

Seasonal Variation Data

Example 4:
Calculate the quarterly seasonal forecast as per given data
Quarter 1 2 3 4 Sales estimate in $ 100000 120000 140000 160000 Quarterly seasonal Seasonal forecast in $ indices 1.3 0.9 0.7 1.15 1.3*100000=130000 0.9*120000=108000 0.7*140000=98000 1.15*160000=184000

Consider Example-5 for forecasting based upon seasonal variation data and Example-6 Trend projection data

QUESTIONS