Forecasting Models

Forecasting
 Managers are always trying to reduce uncertainty and make better estimates of what will happen in the future
 This is the main purpose of forecasting
 Some firms use subjective methods (Seat-of-the pants methods, intuition, experience)
 There are also several quantitative techniques (Moving averages, exponential smoothing, trend projections, least squares
regression analysis)
 Forecasting is a method for translating past experience into estimates of the future
 Virtually used by most management decisions such as:
Production levels
Technological developments
Needed manpower
Governmental regulations
Needed Funds
Training needs
Resource needs
Sale levels.  The most critical information to forecast
Forecasting Models
Forecasting
Qualitative Forecasting Techniques
Used when:
 Past data cannot Qualitative
be used reliably to predict Time-Series
the future. Causal
Models Methods Methods
 Technological trends
 Regulations
 When no past data isDelphi
available, usually because Moving Regression
Methods Average Analysis
o the situation is very new.
 Entry into new markets
 Development ofJury newofproducts
Executive Exponential Multiple
Opinion Smoothing Regression
Sales Force Trend

Composite Projections
Consumer Decomposition
Market Survey
Qualitative Models
 Delphi Method – an iterative group process where (possibly geographically dispersed) respondents provide input to decision
makers
 Jury of Executive Opinion – collects opinions of a small group of high-level managers, possibly using statistical models for
analysis
 Sales Force Composite – individual salespersons estimate the sales in their region and the data is compiled at a district or
national level
 Consumer Market Survey – input is solicited from customers or potential customers regarding their purchasing plans
Eight steps to forecasting :

1. Determine the use of the forecast—what objective are we trying to obtain?
2. Select the items or quantities that are to be forecasted
3. Determine the time horizon of the forecast
4. Select the forecasting model or models
5. Gather the data needed to make the forecast
6. Validate the forecasting model
7. Make the forecast
8. Implement the results
Scatter Diagrams
Scatter diagrams are helpful when forecasting time-series data because they depict the relationship between variables.
450
For Television:
 400 Radios
Sales appear to be constant over time
350 Sales = 250
Televisions
Annual Sales
300
 A good estimate of sales in year 11 is 250 televisions
250
200
For Radios:
 150Sales appear to be increasing at a constant rate of 10 radios per year
100 Sales = 290 + 10(Year)
Compact Discs
 A50reasonable estimate of sales in year 11 is 400 televisions
0
For Compact 0Discs: 2 4 6 8 10 12
 This trend line may not be perfectly accurate
Time (Years)because of variation from year to year
 Sales appear to be increasing
 A forecast would probably be a larger figure each year
Naïve Forecasting Model

 Naïve Forecasting assumes that the value of the series next period will be the same as it is this period. This serves as a
benchmark model to compare the accuracy of a certain forecast.
 The formula for the Naïve Model is:
Ft+1 = xt
where,
Ft+1 = Forecast for next period
xt = Observed value for this period
Using a naïve forecasting model:
ACTUAL ABSOLUTE VALUE OF

YEAR SALES OF CD PLAYERS FORECAST SALES ERRORS (DEVIATION), (ACTUAL – FORECAST)
1 110 — —
2 100 110 |100 – 110| = 10
3 120 100 |120 – 110| = 20
4 140 120 |140 – 120| = 20
5 170 140 |170 – 140| = 30
6 150 170 |150 – 170| = 20
7 160 150 |160 – 150| = 10
8 190 160 |190 – 160| = 30
9 200 190 |200 – 190| = 10
10 190 200 |190 – 200| = 10
11 — 190 —
Sum of |errors| = 160
MAD = 160/9 = 17.8
 We compare forecasted values with actual values to see how well one model works or to compare models
Forecast error = Actual value – Forecast value
 One measure of accuracy is the mean absolute deviation (MAD)
MAD=
∑|forecast error|
n
Moving Averages
 Moving averages can be used when demand is relatively steady over time
 The next forecast is the average of the most recent n data values from the time series
 The most recent period of data is added and the oldest is dropped
o This methods tends to smooth out short-term irregularities in the data series
Sum of demands in previous n periods

Moving average forecast =
n
Wallace Garden Supply Example
Weighted
Moving
Averages

Weighted
moving averages use weights to put more emphasis on recent periods

 Often used when a trend or other pattern is emerging
Ft +1 =
∑ ( Weight in period i )(Actual value in period )
∑ (Weights )
w 1 Y t +w2 Y t−1 +. ..+wn Y t−n+1
Ft +1 =
w1 +w2 +. . .+wn
where
wi = weight for the ith observation
Example:
 Wallace Garden Supply decides to try a weighted moving average model to forecast demand for its Storage Shed
 They decide on the following weighting scheme

Forecasting Models

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Forecasting

Sales Force Trend

Eight steps to forecasting :

Naïve Forecasting Model

Using a naïve forecasting model:

ACTUAL ABSOLUTE VALUE OF

 One measure of accuracy is the mean absolute deviation (MAD)

Sum of demands in previous n periods

moving averages use weights to put more emphasis on recent periods

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