P. 1
Production Operation[1]

Production Operation[1]

|Views: 11|Likes:
Published by Neelam Yadav

More info:

Published by: Neelam Yadav on Feb 14, 2012
Copyright:Attribution Non-commercial


Read on Scribd mobile: iPhone, iPad and Android.
download as PPT, PDF, TXT or read online from Scribd
See more
See less








Production Operation Management
POM concerns itself with the conversion of inputs into outputs, using physical resourses, so as to provide the desired utility/ utilities ± of form, place, possession or state or a combination thereof ± to the customer while meeting the other organisational objectives of effectiveness, efficiency and adaptability.

Production and Operations Management ± Some Cases
Case Input Physical Resource/s used Chemical plant & equipment, other chemicals, use of labour, etc. Doctors, nurses, other staff, equipment, other facilities Output Type of Input/ Output Physical input and physical output Physical input and physical output Type of utility provided to the customers Form

1. Inorganic chemicals production 2. Outpatient ward of a general hospital


Inorganic chemical

Unhealth y Patients

Healthier patients


3. Educational institution

µRaw¶ minds

Teachers, books, teaching aids, etc. Personnel, office equipment and facilities, etc. Operators and boys, equipment, etc.

µEnlightened¶ minds

Physical input and physical output Non-physical input and Nonphysical output Physical input and physical output


4. Sales office

Data from market

Processed µinformation¶


5. Petrol pump

Petrol (in possession of the petrol pump owner) Customer (at railway station) Equipment gone µbad¶

Petrol (in possession of the car owner) Customer (at his residence)


6. Taxi Service

Driver taxi itself, petrol

Physical input and physical output Physical input and physical output Non-physical input and physical output


7. Maintenance workshop 8. Income Tax office

Mechanics, Engineers, repairs equipment, etc. Officers and other staff, office facility

µGood¶ Equipment

State and Form

µInformation ¶


State (possession?)

Production and operations management (POM) is defined as the design, operation, and improvement of the transformation process, which converts the various inputs into the desired outputs of products and services. It is now replaced by simply operations management. Operations management is a broad term which includes manufacturing as well as service organizations. Operations management also highlights the increasing importance of service industry in the overall business environment.

Today's Factors Affecting OM
‡ Global Competition ‡ Quality, Customer Service, and Cost Challenges ‡ Rapid Expansion of Advanced Technologies ‡ Continued Growth of the Service Sector ‡ Scarcity of Operations Resources ‡ Social-Responsibility Issues

Studying Operations Management
‡ Operations as a System ‡ Decision Making in OM

Operations as a System
Production System Conversion Subsystem
Control Subsystem



Inputs of an Operations System
‡ External
± Legal, Economic, Social, Technological

‡ Market
± Competition, Customer Desires, Product Info.

‡ Primary Resources
± Materials, Personnel, Capital, Utilities

Conversion Subsystem
‡ ‡ ‡ ‡ ‡ ‡ Physical (Manufacturing) Locational Services (Transportation) Exchange Services (Retailing) Storage Services (Warehousing) Other Private Services (Insurance) Government Services (Federal)

Outputs of an Operations System
‡ Direct
± Products ± Services

‡ Indirect
± Waste ± Pollution ± Technological Advances

Transformation Process
Transformation process for a hybrid service and manufacturing organization ( a restaurant)
Quality of inputs monitored Random Disturbances ‡ High turnover of chefs, waiters, etc. ‡ Inflation ‡Govt.¶s taxation policy Quality of outputs monitored

Customer satisfied with

Inputs ‡ Customers
‡ Waiters ‡ Chef ‡ Manager ‡ Furniture ‡ Building ‡ Food

Transformation Process

‡ Good preparations of the food ‡ Pleasant behaviour and personality of the waiters ‡ Appropriate prices charged

Feedback mechanisms ‡ Rising revenues ‡ Repeat customers ‡ Appreciation of customers

Decision Making in OM
‡ Strategic Decisions ‡ Operating Decisions ‡ Control Decisions

Strategic Decisions
‡ These decisions are of strategic importance and have long-term significance for the organization. ‡ Examples include deciding:
± the design for a new product¶s production process ± where to locate a new factory ± whether to launch a new-product development plan

Operating Decisions
‡ These decisions are necessary if the ongoing production of goods and services is to satisfy market demands and provide profits. ‡ Examples include deciding:
± how much finished-goods inventory to carry ± the amount of overtime to use next week ± the details for purchasing raw material next month

Control Decisions
‡ These decisions concern the day-to-day activities of workers, quality of products and services, production and overhead costs, and machine maintenance. ‡ Examples include deciding:
± labor cost standards for a new product ± frequency of preventive maintenance ± new quality control acceptance criteria

Production is the process of making products. In this process, different inputs like materials, human, capital and other resources are transformed into higher valued goods and services. ³Production is a process by which goods and service are created.´

Objectives of production management
1. Primary objectives ‡ Quality ‡ Quantity ‡ Cost/ price ‡ Time

2. Secondary objectives ‡ Men ‡ Materials ‡ Machines ‡ Services ‡ Techniques

Functions of production management 
Production design Development of product Purchasing Plan implementation Inventory control

Production vs. Operations vs. Material Management
‡ These are interrelated but there is a line of difference between three. Production is the transformation of raw materials and other inputs into higher valued outputs. Management of materials as input is known as material management. Management of processes or operations is operations management.

Product Life Cycle
Sales and Profits Over the Product¶s Life From Introduction to Decline
Sales and Profits ($) Sales

Profits Time Product Development Losses/ Investments ($) Introduction Growth Maturity Decline

Introduction Stage of the PLC
Summary of Characteristics, Objectives, & Strategies
Sales Costs Profits Marketing Objectives Product Price Distribution Advertising
Low sales High cost per customer Negative or low Create product awareness and trial Offer a basic product Usually is high; use cost-plus formula High distribution expenses Build product awareness among early adopters and dealers

Growth Stage of the PLC
Summary of Characteristics, Objectives, & Strategies
Sales Costs Profits Marketing Objectives Product Price Distribution Advertising
Rapidly rising sales Average cost per customer Rising profits Maximize market share Offer new product features, extensions, service, and warranty Price to penetrate market Increase number of distribution outlets Build awareness and interest in the mass market

Maturity Stage of the PLC
Summary of Characteristics, Objectives, & Strategies
Sales Costs Profits Marketing Objectives Product Price Distribution Advertising
Peak sales Low cost per customer High profits, then lower profits Maximize profits while defending market share Diversify brand and models Price to match or best competitors Build more intensive distribution Stress brand differences and benefits

Decline Stage of the PLC
Summary of Characteristics, Objectives, & Strategies
Sales Costs Profits Marketing Objectives Product Price Distribution Advertising
Declining sales Low cost per customer Declining profits Reduce expenditure and maintain, reposition, harvest or drop the product Phase out weak items Cut price Go selective: phase out unprofitable outlets Reduce to level needed to retain hard-core loyal customers

Classification of Operations
The production and operations management function can be broadly divided into the following four areas: 1. Technology selection and management 2. Capacity management 3. Scheduling/Timing/Time allocation 4. System maintenance

Technology selection and management
This is primarily an aspect pertaining to the long-term decision. It is not immediate connected with the day-to-day short term decisions handled in the plant, it is an important problem to be addressed in an age of spectacular technological advances, so that an appropriate choice is made by a particular organization to suit its objectives, organizational preparedness and its micro-economic perspectives.

It is a decision that will have a significant bearing on the management of manpower, machinery, and materials capacity of the operations system. A technology decision is closely linked with the capacity and system maintenance areas.

Capacity Management
The capacity management aspect once framed in a long-term perspective, revolves around matching of available capacity to demand or making certain capacity available to meet the demand variation. This is done on both the intermediate and short time horizons. Capacity management is very important for achieving the organisational objectives of efficiency, customer service and overall effectiveness. While lower than needed capacity results in non-fulfillment of some of the customer services and other objectives of the production/operations system a higher than

necessary capacity results in lowered utilisation of the resourses or, in other words, lower efficiency of the conversion operations.

Scheduling is another decision area of operations management which deals with the timing of various activities ± time phasing of the filling of the demands or rather, the time phasing of the capacities to meet the demand as it keeps fluctuating. In job-shop (i.e. tailor-made physical output or service) type operations systems, the scheduling decisions are very important which determine the system effectiveness (e.g. customer delivery) as well as the system efficiency (i.e. the productive use of the machinery and labour). Similarly, we can also say that the need for system effectiveness coupled with system efficiencies determine the system structure and the importance of scheduling.

System Maintenance
The fourth area of operations management is regarding safeguards ± that only desired outputs will be produced in the µnormal¶ condition of the physical resources, and that the condition will be maintained normal. Technology selection and management has much to contribute towards this problem. A proper selection and management procedure would give rise to few problems. Further, the checks (e.g. quality checks on physical/non-physical output) on the system performance and the corrective action (e.g. repair of an equipment) would enhance the chances of having the desired outputs undiluted by other pollutants.

Responsibilities of Operations Manager
To act as internal quality auditors in certification programmes such as ISO 9000 To take part in strategic decision making of the organization. To implement Total Productive Maintenance (TPM) programme To take part in the implementation and use of ERP software in the organization. To automate processes according to the requirements of the organization To enhance the R & D efforts of the organization for becoming self-reliant in developing new technologies.

Increased attention to technology management in view of joint ventures of MNCs with domestic companies.

To act as supply chain managers in in forging longterm strategic relationships with suppliers.

To take care of issues relating to service operations management

To act as a member of the concurrent engineering team in new product design.

To take decisions regarding outsourcing/ off-shoing of business processes

To implement the environment and pollution norms established by the government from time to time.

Increased attention to timely implementation of projects (such as commissioning of facilities, launching of new products/services, etc.) in view of the increased competition.

New-Product Development Process
Marketing Strategy Concept Development and Testing Idea Screening Idea Generation Business Analysis Product Development

Test Marketing Commercialization

New Product Development Process
Step 1. Idea Generation Idea Generation is the Systematic Search for New Product Ideas Obtained Internally From Employees and Also From:





New Product Development Process
Step 2. Idea Screening
‡ Process to spot good ideas and drop poor ones as soon as possible. ‡ Many companies have systems for rating and screening ideas which estimate: ± Market Size ± Product Price ± Development Time & Costs ± Manufacturing Costs ± Rate of Return ‡ Then, the idea is evaluated against a set of general company criteria.

New Product Development Process
Step 3. Concept Development & Testing
1. Develop New Product Ideas into Alternative Detailed Product Concepts

2. Concept Testing - Test the New Product Concepts with Groups of Target Customers

3. Choose the One That Has the Strongest Appeal to Target Customers

New Product Development Process
Step 4. Marketing Strategy Development Marketing Strategy Statement Formulation
Part One Describes Overall:
Target Market Planned Product Positioning Sales & Profit Goals Market Share

Part Two Describes Short-Term:
Product¶s Planned Price Distribution Marketing Budget

Part Three Describes Long-Term:
Sales & Profit Goals Marketing Mix Strategy

New Product Development Process
Step 5. Business Analysis Step 6. Product Development
Business Analysis
Review of Product Sales, Costs, and Profits Projections to See if They Meet Company Objectives

If No, Eliminate Product Concept If Yes, Move to Product Development

New Product Development Process
Step 7. Test Marketing
Test Marketing is the Stage Where the Product and Marketing Program are Introduced into More Realistic Market Settings.
Budget Levels Product



Elements that May be Test Marketed by a Company

Positioning Strategy




New Product Development Process
Step 8. Commercialization

Commercialization is the Introduction of the New Product into the Marketplace.



Facility Location Planning

A factory or a plant is the manufacturing facility of a company. A warehouse is the storage facility of a manufacturing or a distribution company. The offices of a service sector company such as a courier company, a bank, or an insurance company are its facilities. The facility location decision is very important for big business houses as well as new entrepreneurs. Wrong location of the facility may lead to a failure of the complete project.

Factors affecting Facility Location Planning
Good transportation facilities Proximity to raw material Availability Of power supply Basic amenities Government policies

Proximity To markets

Facility Location planning

Environment And community

Residential Complexes, Schools, Hospitals, Clubs, etc.

Proximity to subcontractors Availability Of cheap and Skillful labour Low Construction costs Easy Availability Of cheap land

Availability of power supply ± Uninterrupted power supply is a basic requirement of most industries. some factories have to set up their own captive power plant if located in areas with power problems. For eg: the factories of HINDALCO (Aditya Birla Group) have their own captive power plant. Basic amenities ± The area for location of plant should have water supply lines managed by the local municipal corporation. Roads up to the factory premises are always desireable. These basic amenities are very useful even during the construction period of the plant. Other amenities desired are sanitation facilities such as sewer lines, drainage system, etc. Government Policies ± The governments of state such as Maharashtra, Gujarat, and Karnataka have been very successful in inducing big business houses to set up their plants in these states. Local taxation policies and various promotional efforts help in increasing the industrial activity in the region. Pondicherry and Daman and Diu are examples of µno sales tax regions¶.

Environmental and community considerations- Many state governments have strict environmental policies in place, which have to be followed by the industries operating there. The people residing in the area should not be against the idea of having a plant in their region as the effluents from a factory spoil the natural environment of the region. Proximity to subcontractors- The presence of small ancillary units manufacturing small components/sub-assemblies is important for any new factory. If a new auto plant is set up in Gurgaon, where the Maruti Suzuki plant is already located, it will get the advantage of the subcontractors existing there. These subcontractors can immediately start supplying the components required by the new plant for starting its production process. Easy availability of cheap land- Land is the basic necessity for the construction of a new plant. Regions such as UP, Bihar, and Orissa may be suitable because of this. Still, because of many other factors, companies prefer costly land near Mumbai, Pune, Ahmedabad, etc.

Less Construction costs- Construction costs of a plant may be low at a particular place due to cheap labour available there. The construction material may also be cheaper at another place. Such places are obviously preffered for locating a plant. Availability of cheap, skillful and efficient labour- India and other developing nations appear to have cheap labour. However, the reality is that labour turns to be expensive here because it is not efficient when compared to the labour in developed countries. Multinational companies prefer China over India to set up their global sourcing bases because the labour in china has become more skillful and efficient as a result of increased industrial activity in the past few decades. Residential complexes, schools, hospitals, clubs, etc. ± Usually new factories are given land in remote villages by the state governments. Proper facilities such as residential complexes, schools, hospitals, clubs, etc. are not available for the managers of these plants and their families at such places. Under such situations, companies have to create these facilities on their own.

Proximity to customers (markets)- When the customers/markets are located near the plant, products can be easily supplied to them. This reduces the cost of the product as the transportation cost is not added to it. Proximity to raw material- Most textile units are located in Gujarat and Maharashtra because these are the largest cotton-growing areas in the country. Iron and steel plants are located in Bihar and Orissa because of the large presence of iron ore mines in these regions. Good transportation facilities- Regions near metro cities have the advantage of good transportation facilities, as they have good rail, air, water and road transportation networks.

The Production Cycle

‡ The production cycle is a recurring set of business activities and related data processing operations associated with the manufacture of products.

‡ Questions to be addressed in this topic include:
± What are the basic business activities and data processing operations that are performed in the production cycle? ± What decisions need to be made in the production cycle, and what information is needed to make these decisions? ± How can the company¶s cost accounting system help in achieving the entity¶s objectives? ± What are the major threats in the production cycle and the controls that can mitigate those threats?

‡ Information flows to the production cycle from other cycles, e.g.:
± The revenue cycle provides information on customer orders and sales forecasts for use in planning production and inventory levels. ± The expenditure cycle provides information about raw materials acquisitions and overhead costs. ± The human resources/payroll cycle provides information about labor costs and availability.

‡ Information also flows from the production cycle:
± The revenue cycle receives information from the production cycle about finished goods available for sale. ± The expenditure cycle receives information about raw materials needs. ± The human resources/payroll cycle receives information about labor needs. ± The general ledger and reporting system receives information about cost of goods manufactured.

‡ Decisions that must be made in the production cycle include:
± What mix of products should be produced? ± How should products be priced? ± How should resources be allocated? ± How should costs be managed and performance evaluated?

‡ These decisions require cost data well beyond that required for external financial statements.


PRODUCTION CYCLE ACTIVITIES cycle are: The four basic activities in the production
± ± ± ± Product design Planning and scheduling Production operations Cost accounting

‡ Accountants are primarily involved in the fourth activity (cost accounting) but must understand the other processes well enough to design an AIS that provides needed information and supports these activities.

‡ The objective of product design is to design a product that strikes the optimal balance of:
± Meeting customer requirements for quality, durability, and functionality; and ± Minimizing production costs.

‡ Key documents and forms in product design:
± Bill of Materials: Lists the components that are required to build each product, including part numbers, descriptions,and quantity. ± Operations List: Lists the sequence of steps required to produce each product, including the equipment needed and the amount of time required.

‡ Role of the accountant in product design:
± Participate in the design, because 65í80% of product cost is determined at this stage. ± Add value by:
‡ Designing an AIS that measures and collects the needed data.
‡ Information about current component usage. ‡ Information about machine set-up and materials-handling costs. ‡ Data on repair and warranty costs to aid in future modification and design.

‡ The objective of the planning and scheduling activity is to develop a production plan that is efficient enough to meet existing orders and anticipated shorter-term demand while minimizing inventories of both raw materials and finished goods.

‡ Key documents and forms:
‡ ‡ ‡ ‡ ‡


± Master production schedule
Specifies how much of each product is to be produced during the period and when. Uses information about customer orders, sales forecasts, and finished goods inventory levels to determine production levels. Although plans can be modified, production plans must be frozen a few weeks in advance to provide time to procure needed materials and labor. Scheduling becomes significantly more complex as the number of factories increases. Raw materials needs are determined by exploding the bill of materials to determine amount needed for current production. These amounts are compared to available levels to determine amounts to be purchased.

‡ Key documents and forms:
± Master production schedule ± Production order


‡ Authorizes production of a specified quantity of a product. It lists:
± Operations to be performed ± Quantity to be produced ± Location for delivery

‡ Also collects data about these activities,

‡ Key documents and forms:
± Master production schedule ± Production order ± Materials requisition
‡ Authorizes movement of the needed materials from the storeroom to the factory floor. ‡ This document indicates:
± Production order number ± Date of issue ± Part numbers and quantities of raw materials needed (based on data in bill of materials)

‡ Key documents and forms:
± Master production schedule ± Production order ± Materials requisition ± Move ticket


‡ Documents the transfer of parts and materials throughout the factory.

‡ The objectives of cost accounting are:
± To provide information for planning, controlling, and evaluating the performance of production operations; ± To provide accurate cost data about products for use in pricing and product mix decisions; and ± To collect and process information used to calculate inventory and COGS values for the financial statements.

‡ Types of cost accounting systems:
± ‡Job order costing production batch or job. Assigns costs to a specific
‡ Used when the product or service consists of discretely identifiable items.

‡ In the production cycle (or any cycle), a well-designed AIS should provide adequate controls to ensure that the following objectives are met:
± ± ± ± ± ± ± All transactions are properly authorized. All recorded transactions are valid. All valid and authorized transactions are recorded. All transactions are recorded accurately. Assets are safeguarded from loss or theft. Business activities are performed efficiently and effectively. The company is in compliance with all applicable laws and regulations. ± All disclosures are full and fair.

‡ There are several actions a company can take with respect to any cycle to reduce threats of errors or irregularities. These include:
± Using simple, easy-to-complete documents with clear instructions (enhances accuracy and reliability). ± Providing space on forms to record who completed and who reviewed the form (encourages proper authorizations and accountability).

± Pre-numbering documents (encourages recording of valid and only valid transactions). ± Restricting access to blank documents (reduces risk of unauthorized transaction).

‡ In the following sections, we¶ll discuss the threats that may arise in the four major steps of the production cycle, as well as general threats

‡ THREAT NO. 1²Poor product design
± Why is this a problem?
‡ Higher materials purchasing and carrying costs. ‡ Costs for inefficient production. ‡ Higher repair and warranty costs. ± Controls: ‡ Accurate data about the relationship between components and finished goods. ‡ Analysis of warranty and repair costs to identify primary causes of product failure to be used in redesigning product.

‡ THREAT NO. 2²Over- or under-production
± Why is this a problem?
‡ Over-production may result in:
± Excess goods for short-run demand and potential cash flow problems. ± Obsolete inventory.

‡ Under-production may result in:
± Lost sales. ± Customer dissatisfaction.

± Controls:
‡ More accurate production planning, including accurate and current:
± Sales forecasts ± Inventory data

‡ Investments in production planning. ‡ Regular collection of data on production performance to adjust production schedule. ‡ Proper authorization of production orders. ‡ Restriction of access to production scheduling program.

‡ THREAT NO. 3²Suboptimal investment in fixed assets
± Why is this a problem?
‡ Over-investment causes excess costs. ‡ Under-investment impairs productivity.

± Controls:
‡ Proper authorization of fixed asset transactions:

‡ THREAT NO. 4²Theft of inventories and fixed assets
± Why is this a problem?
‡ Loss of assets. ‡ Misstated financial data.

± Controls:
‡ All internal movement of inventory should be documented. ‡ Materials requisitions should be used to authorize release of raw materials.
± Should be signed by both inventory control clerk and production employee to establish accountability.

‡ Requests in excess of the bill of materials should be documented and have supervisory authorization.

‡ Managers should be held accountable for assets under their control. ‡ Fixed assets should be physically secured. ‡ Disposal of assets should be authorized and documented. ‡ Periodic reports of fixed asset transactions should be reviewed by the controller.

‡ THREAT NO. 5²Disruption of operations
± Why is this a problem?
‡ Disasters can disrupt functioning and destroy assets

± Controls:
‡ Backup power sources, such as generators and uninterruptible power supplies. ‡ Investigate disaster preparedness of key suppliers and identify alternative sources for critical components.

‡ THREAT 6²Inaccurate recording and processing of production activity data
± Why is this a problem?
‡ Diminishes effectiveness of production scheduling. ‡ Undermines management¶s ability to monitor and control operations.

± Controls:
‡ Automate data collection with RFID technology, bar code scanners, and badge readers to ensure accurate data entry.

‡ Use online terminals for data entry. ‡ Restrict access with passwords, user IDs, and access control matrices to prevent unauthorized changes to data. ‡ Do periodic physical counts of inventory and compare to records. ‡ Do periodic inspections and counts of fixed assets.

‡ THREAT NO. 7: Loss, alteration, or unauthorized disclosure of data
± Why is this a problem?
‡ Loss or alteration of data could cause:
± Errors in external or internal reporting.

‡ Unauthorized disclosure of confidential information can cause:
± Unfair competition ± Loss of business

‡ Controls:
± All data files and key master files should be backed up regularly. ± All disks and tapes should have external and internal file labels to reduce chance of accidentally erasing important data. ± Promptly, remove all access rights of employees who quit or are fired


Demand Forecasting
Demand Forecasting is predicting the future demand of the products or services of an organization. To forecast is to estimate or calculate in advance. Planning is a fundamental activity of management. Forecasting forms the basis of planning. Be it planning for sales and marketing, or production planning or manpower planning, forecasts are extremely important. Forecasting is a scientifically calculated guess. It is basic to all planning activity ± (i) Whether it is national, regional, organisational, or functional planning; and (ii) Whether it is a long range plan or a short-range plan.

Reasons for Demand Forecastiong
To maximize gains From events external To the organization (from the external Environment). To develop policies That apply to people Who are not part of The organization. To develop administrative Plans and policies internal To an organization (e.g., personnel or budget). To provide adequate Staff to support production requirements. To maximize gains from events which are the results Of actions taken by the organization. To minimize losses associated with uncontrollable events external to the organization To offset the actions of competitor organizations.

Reasons for demand forecasting

As an input to aggregate production Planning and/or materials requirement Planning (MRP).

In decision-making For facility capacity planning and for capital budgeting

Methods of Demand Forecasting
Demand Forecasting

Qualitative analysis

Quantitative analysis

Time Series analysis Customer survey Sales force composition Simple moving average Delphi method Holt¶s doubleExponential smoothing Winters¶ tripleExponential smoothing Simple exponential smoothing

Casual analysis

Trend analysis

Executive opinion

Past analogy

Forecast by linear Regression analysis

Qualitative Methods of Forecasting
There are certain situations in which forecasts have to be prepared quickly without using historical data. At other times, historical data may not be available, resulting in qualitative analysis as the only available forecasting method. For example, in the launch of a new innovative product, there is no data available from past experience on the sales of the product. Thereare five qualitative methods of forecasting. Customer Surveys It is the customers who determines the demand for a product or service. It is practically not possible to identify all the potential customers or to contact all the existing customers, sampling of customers are resorted to. While designing customer survey questionnaires, care has to be taken to frame questions such that the true responses of the customers are solicited. Similarly, the implementation and analysis stages of the survey have to be carefully handled to ensure that the conclusions drawn from the survey reflect the exact pulse of the customers.

Sales Force composite This approach to forecasting is much less expensive compared to customer surveys. The sales force of a company is in direct contact with the customers. Thus, they may be advised to give their estimates about the likely sales of the product in their region. The marketing manager may compile these estimates for different regions to arrive at the overall estimate of the demand forecast for the product. This approach to forecasting has its disadvantages. The sales person¶s estimates may not be as accurate as customer surveys. Executive opinion A jury of top executives of the company from different functional areas such as marketing, finance, human resources, production, etc. are brought together to give their opinion about the forecast of a new product to be launched. This approach to forecasting is particularly suitable for new products, which do not have any past history of sales. In such situations, there is no other option except to depend upon the vast experience of these senior executives in providing the forecast for the new product.

Delphi method This method is named after an ancient Greek astrologer Delphi. In this method, a questionnaire email is sent to experts from various diversified streams, seeking their opinion on the forecast of a (usually highly advanced technology) product. This method is different from executive opinion, as here the experts may not necessarily be top executives. The experts may be technology forecasters, sales persons with varied experiences in promoting path-breaking high-tech products, etc. The opinions expressed by these experts as responses to the questionnaire are kept anonymous. Thus, even experts on the lower rung of the hierarchy feel free to express their opinions. The responses of the experts are compiled and summarized. Past analogy For forecasting the sales of a new product, an analogy of the sales growth trends of other existing products may be taken. These products may be substitutes of the new product, complementary products, or products related to the consumers belonging to income groups similar to that being targeted by the new product. For example, a watch manufacturing company launching a designer range of watches may study the buying patterns of customers who patronize fashionable sunglasses or clothes designed by high-profile fashion designers.

Quantitaive Methods of Forecasting
Time Series Analysis In this method, we require a time series of historical demand data with respect to time intervals (periods) in the past to make predictions for future demand. Five popular methods are used in time series analysis: 1. Simple moving average 2. Simple exponential smoothing 3. Holt¶s double-exponential smoothing 4. Winters¶ triple-exponential smoothing 5. Forecasting by linear regression analysis Simple moving average The simple moving average method of forecasting is suitable under situations where there is neither a growth nor a decline trend, i.e., there is a horizontal trend shown by the actual past data used for forecasting. There can also be seasonal variations in this past data. This method involves finding the simple average of the past data used for forecasting.

In mathematical terms, moving average forecast can be expresses as Ft = At-1 +At-2 +«.+At-n n Example 1 Kids Toys (P) Ltd is a toy marketing company at Mumbai. The sales figures (in units) of a particular toy during the past 20 weeks are given. Calculate the fourweek and eight-week moving average forecasts for the given 20 weeks.
Week Actual demand (units) Week Actual demand (units)

1 2 3 4 5 6 7 8 9 10

1,643 1,821 2,069 1,952 2,178 1,597 1,834 1,852 1,771 2,014

11 12 13 14 15 16 17 18 19 20

2,395 2,683 1,936 2,076 2,103 1,699 2,387 1,854 1,521 1,726

Week No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21

Actual Demand (in units) 1634 1821 2069 1952 2178 1597 1834 1852 1771 2014 2395 2683 1936 2076 2103 1699 2387 1854 1521 1726

Four Week Moving Average

Eight Week Moving Average

#N/A #N/A #N/A 1869 2005 1949 1890.25 1865.25 1763.5 1867.75 2008 2215.75 2257 2272.5 2199.5 1953.5 2066.25 2010.75 1865.25 1872

#N/A #N/A #N/A #N/A #N/A #N/A #N/A 1867.125 1884.25 1908.375 1949.125 2040.5 2010.25 2070.125 2103.75 2084.625 2161.625 2141.625 2032.375 1912.75

2800 2600 2400 2200 2000 1800 1600 1400 1200 1000

Actual demand/forecast

Actual demand (in units) Four-week moving average Eight-week moving average



7 10

13 16



Weighted moving average In calculating the simple moving average, actual demand data in all the past periods considered are given equal importance. Sometimes it is felt that while finding the moving average, the data in the recent past periods should be given more weight or importance compared to the data in the periods far off the current time. For example, let us suppose that for a product the actual demand in months 1, 2, and 3 is 20, 30, and 10 units, respectively. For calculating a three-month moving average forecast for month 4, the company may decide to give 50% importance (weight 0.5) to the data in week 3, 30% importance (weight 0.3) to the data in week 2, and 20% importance (weight 0.2) to the data in week 1. Thus, the weighted three-month moving average forecast for week 4 will be given by F4 = 0.2 x 20 + 0.3 x 30 + 0.5 x 10 0.2 + 0.3 + 0.5 = 4 + 9 + 5 = 18

Simple exponential smoothing Simple exponential smoothing is the most popular forecasting method. It is very simple in application and, in addition, the past data required is limited to just the last period¶s actual demand and its forecast. The forecast using simple exponential smoothing is given by the following equation:

Ft +1 = Dt + (1 - )Ft where: Ft +1 = forecast for next period Dt = actual demand for present period Ft = previously determined forecast for present period = weighting factor, smoothing constant having a value between 0 & 1

Effect of Smoothing Constant 0.0 e If If e 1.0

= 0.20, then Ft +1 = 0.20Dt + 0.80 Ft 0.20D = 0, then Ft +1 = 0Dt + 1 Ft 0 = Ft 0D Forecast does not reflect recent data

If = 1, then Ft +1 = 1Dt + 0 Ft =Dt 1D Forecast based only on most recent data

Selection of smoothing constant
‡ can make the difference between an accurate forecast and an inaccurate forecast. ‡ forecast error = (actual demand)- (forecast demand)

Exponential Smoothing ( =0.30)
F2 = D1 + (1 - )F1 = (0.30)(37) + (0.70)(37) = 37

PERIOD 1 2 3 4 5 6 7 8 9 10 11 12

MONTH Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

DEMAND 37 40 41 37 45 50 43 47 56 52 55 54

F3 = D2 + (1 - )F2 = (0.30)(40) + (0.70)(37) = 37.9

Exponential Smoothing
PERIOD 1 2 3 4 5 6 7 8 9 10 11 12 13 MONTH Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan DEMAND 37 40 41 37 45 50 43 47 56 52 55 54 ± FORECAST, Ft + 1 (E = 0.3) (E = 0.5) ± 37.00 37.90 38.83 38.28 40.29 43.20 43.14 44.30 47.81 49.06 50.84 51.79 ± 37.00 38.50 39.75 38.37 41.68 45.84 44.42 45.71 50.85 51.42 53.21 53.61

Holt¶s double-exponential smoothing Holt¶s double-exponential smoothing is suitable when the actual demand follows either a increasing or a decreasing trend. In Holt¶s doubleexponential smoothing, we use two smoothing constants. One is smoothing constant , and other is , which is used to adjust the trend effect. Forecasting by linear regression analysis Linear regression analysis is applied in situations where two variables are linearly correlated to each other. In time series analysis, the independent variable is time, while the dependent variable is the actual demand in the past. The best-fit line is represented by the straight line equation y = a + bx y = forecast for period x b= slope of the straight line x = specified number of time period

Monitoring and controlling forecasts
‡ Once a forecast has been completed, it needs to be monitored and corrected periodically by determining why actual demand differed significantly from that projected. ‡ This can be done by setting upper and lower limits on how much the performance characteristic of a forecasting model can deteriorate before we change the parameters of the model. ‡ One way to monitor forecasts to ensure that they are performing well is to use a tracking signal. ‡ A tracking signal is a measurement of how well the forecast is predicting actual values. ‡ tracking signal = running sum of forecast errors (RSFE) /mean absolute deviation(MAD) (OR) ‡ tracking signal = forecasting errors/ n

‡ RSFE = (actual demand in period i) ± ( forecast demand in period i) ‡ MAD = (actual demand in period i ± forecast demand in period i)/n n= number of years

Implication of tracking signal
‡ + tracking signals indicate that demand is greater than forecast. ‡ - tracking signals mean that demand is less than forecast. ‡ Once tracking signals are evaluated, they are compared with predetermined control limits. ‡ When a tracking signal exceeds an upper or lower limit, there is some problem with the forecasting method and hence, the forecasting method must be reevaluted.

Factors to be considered in the selection of a forecasting method are ‡ ‡ ‡ ‡ ‡ Cost and accuracy Data available Time span Nature of product and services Impulse response

Reasons for ineffective forecasting
‡ Not involving a broad cross section in forecasting ‡ Not recognizing that forecast will never be correct or accurate ‡ Not recognizing the fact the forecasting is integral to business planning ‡ Not forecasting the right things ‡ Not selecting an appropriate forecasting method ‡ Not tracking the performance of the forecasting models models so that forecast accuracy can be improved.


You're Reading a Free Preview

/*********** DO NOT ALTER ANYTHING BELOW THIS LINE ! ************/ var s_code=s.t();if(s_code)document.write(s_code)//-->