INTRODUCTION:

People make and use forecasts all the time, both in their jobs and in everyday life. In
everyday life, they forecast answers to questions and then make decisions based on their
forecasts. Can I make it across the street before that car comes? “How much food and drink
will I need for the party?” Will I get the job? When should I have leave to make it to class, the
station, bank, the interview….on time? To make these forecasts, they may take into account
two kinds of information. One is current factors or conditions. The other is past experience in
a similar situation. Sometimes they will rely more on one than the other, depending on which
approach seems more relevant at the time.

In this chapter, we examine different types of forecasts and present a variety of

forecasting models. Our purpose is to show that there are many ways for managers to
forecast. We also provide an overview of business sales forecasting and describe how to
prepare, monitor and judge the accuracy of a forecast. Good forecasts are an essential part
of efficient service and manufacturing operations.

INTENDED LEARNING OUTCOMES:

1. Outline the steps in the forecasting process;

2. Describe at least three qualitative forecasting techniques and the advantages and
disadvantages of each;
3. Compare and contrast qualitative and quantitative approaches for forecasting;
4. Briefly describe averaging techniques, trends and seasonal techniques, and
regression analysis and some typical problems;
5. Describe two ways of evaluating and controlling forecasts.

DISCUSSION:
What is forecast/forecasting?

A forecast is a statement about the future value of a variable such as demand. That
is, forecasts are predictions about the future. The better those predictions, the more
informed decisions can be. Some forecasts are long range, covering several years or more.

Forecasting is the art and science of predicting future events. Forecasting may
involve taking historical data and projecting them into the future with some sort of
mathematical model. It may be subjective or intuitive prediction. Or it may involve a
combination of these – that is, mathematical model adjusted by a manager’s good judgment.

ELEMENTS OF GOOD FORECAST

 Should be timely – usually certain amount of time is needed to respond to the

information contained in a forecast.
 Should be accurate – and the degree of accuracy should be stated. This will enable
users to plan for possible errors and will provide a basis for comparing alternative
forecasts.
 Should be reliable – it should work consistently. A technique that sometimes provides
a good forecast and sometimes a poor one will leave users with the uneasy feeling
that they may get burned every time a new forecast is issued.

CHAPTER 3. FORECASTING 1|Page

  Should be expressed in meaningful units – financial planners need to know how many
dollars will be needed, production planners need to know how many units will be
needed, and schedulers need to know what machines and skills will be required.
 Should be in writing. – written forecast will permit an objective basis for evaluating the
forecast once actual results are in.
 Should be simple to understand and use – simple forecasting techniques enjoy
widespread popularity because users are more comfortable working with them.
 Should be cost effective – the benefits should outweigh the costs.

STEPS IN THE FORECASTING PROCESS

1. Determine the purpose of the forecast. This step will provide an indication of the
level of detail required in the forecast, the amount of resources (personnel, computer
time, dollars) that can be justified, and the level of accuracy necessary,
2. Establish a time horizon. The forecast must indicate a time interval, keeping in mind
that accuracy decreases as the time horizon increases.
3. Select a forecasting technique.
4. Obtain, clean, and analyse 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.
5. Make the forecast.
6. Monitor the forecast. A forecast has to be monitored to determine whether it is
performing in a satisfactory manner.

APPROACHES TO FORECASTING

QUALITATIVE APPROACHES

 Consist mainly of subjective inputs, which often defy precise numerical description.
 Permit inclusion of soft information (ex. Human factors, personal opinions, hunches)

QUANTITATIVE APPROACHES

 Involve either the projection of historical data or the development of associative

models that attempt to utilize causal (explanatory) variables to make forecast.
 Consist mainly of analyzing objective, or hard, data. They usually avoid personal
biases that sometimes contaminate qualitative methods. In practice, either or both
approaches might be used to develop a forecast.

OVERVIEW OF QUALITATIVE METHODS

In this section, we consider four different qualitative techniques:

1. Jury of executive opinion. Under this method, the opinions of a group of high-level
experts or managers, often in combination with statistical models, are pooled to arrive
at a group estimate of demand.

2. Delphi Method. There are three different types of participants in the Delphi Method:
decision makers, staff personnel, and respondents. Decision makers usually consists
of a group of 5 to 10 experts who will be making the actual forecast. Staff personnel
assist decision makers by preparing, distributing, collecting, and summarizing a series
of questionnaires and survey results. The respondents are a group of people, often
located in different places, whose judgments are valued.

CHAPTER 3. FORECASTING 2|Page

 3. Sales force composite. In this approach, each salesperson estimates what sales will
be in his or her region. These forecasts are then reviewed to ensure that they are
realistic. Then they are combined at the district and national levels to reach an overall
forecast.

4. Consumer market survey. This method solicits input from customers or potential
customers regarding future purchasing plans. It can help not only in preparing a
forecast but also in improving product design and planning for new products.

OVERVIEW OF QUANTITATIVE METHODS

Five quantitative forecasting methods, all of which use historical data, are describe in
this chapter. They fall into two categories:

I. Time-Series Models

A time series is based on a sequence of evenly spaced (weekly, monthly,

quarterly, and so on) data points. Forecasting time-series data implies that
future values are predicted only from past values and that other variables, no
matter how potentially valuable, may be ignored.

Decomposition of a Time Series

1. Trend is the gradual upward or downward movement of the data over time.
Changes in income, population, age distribution, or cultural views may account for
movement in trend.

2. Seasonality is a data pattern that repeats itself after a period of days, weeks,
months, or quarters. There are six common seasonality patterns:

Period of Pattern “Season” Length Number of “Seasons”

in Pattern
Week Day 7
Month Week 4 – 4.5
Month Day 28-31
Year Quarter 4
Year Month 12
Year Week 52

3. Cycles are patterns in the data that occur every several years. They are usually
tied into the business cycle and are of major importance in short-term business
analysis and planning.
4. Random variations are “blips” in the data caused by chance and unusual
situations. They follow no discernible pattern, so they cannot be predicted.

a. Naïve approach – the simplest way to forecast is to assume that demand in

the next period will be equal to demand in the most recent period. This naïve
approach is the most cost effective and efficient objective forecasting model.
At least it provides a starting point against which more sophisticated models
that follow can be compared.

b. Moving averages – moving average forecast uses a number of historical

actual data values to generate a forecast. It is useful if we can assume that
market demands will stay fairly steady over time. A 4-month moving average is

CHAPTER 3. FORECASTING 3|Page

 found by simply summing the demand during the past to the sum of the
previous 3months’ data, and the earliest months is dropped. This practice tends
to smooth out short-term irregularities in the data series.

Mathematically, the simple moving average (which serves as an

estimate of the next period’s demand ) is expressed as

Moving average = ∑demand in previous n periods

N
Where n is the number of periods in the moving average – for example,
4,5 or 6 months, respectively, for a 4-, 5, or 6-period moving average.

Example 1 shows how moving averages are calculated.

Donna’s Garden Supply wants a 3-month moving average forecast, including a forecast for
next January, for shed sales.

APPROACH Storage shed sales are shown in the middle column of the table below. A 3-
month moving average appears on the right.

Month Actual Shed 3-Month Moving

Sales Average
January 10
February 12
March 13
April 16
May 19
June 23
July 26
August 30
September 28
October 18
November 16
December 14
January

c. Weighted Moving Average – When a detectable trend or pattern is present,

weights can be used to place more emphasis on recent values. This practice
makes forecasting techniques more responsive to changes because more
recent periods may be more heavily weighted. Choice of weights is somewhat
arbitrary because there is no set formula to determine them. Therefore,
deciding which weights to use requires some experience. For example, if the
latest month of period is weighted too heavily, the forecast may reflect a large
unusual change in the demand or sales pattern too quickly.

A weighted moving average may be expressed mathematically as:

Weighted moving average = ∑ (weight for period n) (Demand in period

n)
∑ Weights
Example 2 shows to calculate a weighted moving average.

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Example 2 shows how to calculate a weighted moving average.

Donna’s Garden Supply wants to forecast storage shed sales by weighting the past 3
months, with more weight given to recent data to make them more significant.

Month Actual Shed 3-Month Moving

Sales Average
January 10
February 12
March 13
April 16
May 19
June 23
July 26
August 30
September 28
October 18
November 16
December 14
January

d. Exponential Smoothing – is a sophisticated weighted-moving average

forecasting method that is still fairly easy to use. It involves very little record
keeping of past data. The basic exponential smoothing formula can be shown
as follows:

New Forecast = Last period’s forecast

+ α (Last period’s actual demand- Last period’s forecast)

Where α is a weight, or smoothing constant, chosen by the forecaster,

that has a value between 0 and 1. Equation (4-3) can also be written
mathematically as:

Ft = Ft-1 + α(At-1 – Ft-1)

Where Ft = new forecast

Ft-1 = previous period’s forecast
Α = smoothing (or weighting) constant (0 ≤ α ≤ 1)
At-1 = previous period’s actual demand

The concept is not complex. The latest estimate of demand is equal to the
old estimate adjusted by a fraction of the difference between the last
period’s actual demand and the old estimate.

Example:

In January, a car dealer predicted February demand for 142 Ford Mustangs. Actual February
demand was 153 autos. Using a smoothing constant chosen by management of α = .20, the
dealer wants to forecast. March demand using the exponential smoothing model.

Approach The exponential smoothing model in Equation above can be applied.

Given: Ft-1 = 142

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 A =(.20)
At-1 = 153

Solution: Ft = Ft-1 + α(At-1 – Ft-1)

Solution Substituting the sample data into the formula, we obtain:

New forecast (for March demand) = 142 +.2 (153-142) = 142 + 2.2

Answer : 144.2 Thus, the March demand forecast for Ford Mustangs is rounded to 144.

MEASURING FORECAST ERROR

The overall accuracy of any forecasting model – moving average, exponential

smoothing, or other – can be determined by comparing the forecasted values with the actual
or observed values. If F denotes the forecast in period t, and At denotes the actual demands
in period t, the forecast error (or deviation) is defined as:

Forecast error = Actual demand – Forecast value

= At – Ft

Several measures are used in practice to calculate the overall forecast error. These measures
can be used to compare different forecasting models, as well as to monitor forecasts to ensure
they are performing well. Three of the most popular measures are mean absolute deviation
(MAD), mean squared error (MSE), and the mean absolute percentage error (MAPE). We
now describe and give an example of each.

MEAN ABSOLUTE DEVIATION (MAD) – the first measure of the overall forecast error for a
model is the mean absolute deviation (MAD). This value is computed by taking the sum of the
absolute values of the individual forecast errors (deviations) and dividing by the number of
periods of data (n):

MAD = ∑ (Actual – Forecast)

N

Example:

During the past 8 quarters, the Port of Baltimore has unloaded large quantities of grain from ships. The
port’s operations manager wants to test the use of exponential smoothing to see how well the technique
works in predicting tonnage unloaded. He guesses that the forecast of grain unloaded in the first quarter
was 175 tons. Two values of ᵆ are to be examined: ᵆ = .10 and ᵆ =.50

Approach: Compare the actual data with the date we forecast (using each of the two ᵆ values) and
then find the absolute deviation and MADs.

Quarter Actual Forecast with ᵆ = .10 Forecast with ᵆ = .50

Tonnage
Unloaded
1 180 175 175
2 168
3 159
4 175
5 190

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 6 205
7 180
8 182
9 ?

MEAN SQUARED ERROR. The mean squared error (MSE) is a second way of measuring
overall forecast error. MSE is the average of the squared differences between the forecasts
and observed values.

MSE = ∑ (forecast errors)2

N
Example: below finds the MSE for the Port of Baltimore introduced in the previous example.

The operations manager for the Port of Baltimore now wants to compute MSE for ᵆ = .10

APPROACH. Use the same forecast data for ᵆ = .10 from previous example, then compute the MSE
using the following.

Quarters Actual Forecast Forecast (Error)2

Tonnage For Error
Unloaded a=.10
1 180 175
2 168 175.50
3 159 174.75
4 175 173.18
5 190 173.36
6 205 175.02
7 180 178.02
8 182 178.22

What is the Mean Squared Error (MSE)?

MEAN ABSOLUTE PERCENTAGE A problem with both the MAD and MSE is that their values
depend on the magnitude of the item being forecast. If the forecast item is measured in thousands,
the MAD and MSE values can be very large. To avoid this problem, we can use the mean absolute
percent error (MAPE). This is computed as the average of the absolute difference between the
forecasted and actual values, expressed as percentage of the actual values. That is, if we have
forecasted and actual values for n periods, the MAPE is calculated is:

MAPE = ∑ absolute percent error

n

Quarter Actual Forecast Absolute Percent Error 100

Tonnage for (error/actual)
Unloaded ᵆ =.10
1 180
2 168
3 159
4 175
5 190
6 205
7 180
8 182

CHAPTER 3. FORECASTING 7|Page

 II. Associative Model

a. Trend projection – The last time-series forecasting method we will discuss is

trend projection. This technique fits a trend line to a series of historical data
points and then projects the line into the future for medium to long-range
forecasts. Several mathematical trend equations can be developed (for
example, exponential and quadratic), but in this section, we will look at linear
(straight line) trends only.

SEASONAL VARIATIONS IN DATA – Seasonal variations in data are regular

up and down movements in a time series that relate to recurring events such
as weather of holidays. Demand for coal and fuel oil, for example, peaks during
cold winter months. Demand for golf clubs or sunscreen may be highest in
summer.

CYCLICAL VARIATIONS IN DATA - are like seasonal variations in

data but occur every several years, not weeks, months or quarters. Forecasting
cyclical variations in a time series is difficult. This is because cycles include a
wide variety of factors that cause the economy to go from recession to
expansion to recession over a period of years.

b. ASSOCIATIVE FORECASTING METHODS: REGRESSION AND

CORRELATION ANALYSIS
Unlike time-series forecasting, associative forecasting models usually consider
several variables that are related to the quantity being predicted. Once these
related variables have been found, a statistical model is built and used to
forecast the item of interest. This approach is more powerful than the time-
series methods that use only the historical values for the forecasted variable.

1. Sales of Volkwagen’s popular Beetle have grown steadily at auto dealerships in

Nevada during the past 5 years (see table below). The sales manager had predicted
in 2004 that 2005 sales would be 410VWs. Using exponential smoothing with a
weight of α = .30, develop forecasts for 2006 through 2010.

Year Sales Forecast

2005 450 410
2006 495
2007 518
2008 563
2009 584
2010 ?

2. The following gives the number of pints of type A blood used at Woodlawn Hospital in
the past 6 weeks.

Week of Pints used

August 31 360
September 7 389
September 14 410
September 21 381
September 28 368
October 5 374

CHAPTER 3. FORECASTING 8|Page

 a.) Forecast the demand for the week of October 12 using a 3-week moving average;
b.) Use a 3-week weighted moving average, with weights of (.1), (.3), and (.6) using .6
for the most recent week. Forecast demand for the week of October 12.
c.) Compute the forecast for the week of October 12 using exponential smoothing with a
forecast for August 31 of 360 and α = .2

3. A check-processing center uses exponential smoothing to forecast the number of

incoming checks each month. The number of checks received in June was 40million,
while the forecast was 42 million. A smoothing constant of .2 is used.
a.) What is the forecast for July?
b.) If the center received 45million checks in July, what would be the forecast for
August?

REFERENCES:

Stevenson, Operations Management Second Edition, C2013

th

Render, Heizer, Operations Management, 10 Edition,C2011

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