Objective and Subjective Forecasting Approaches

(second in a series)

Today we discuss the various categories of forecasting methods that are available to
businesses. Forecasting methods can be either objective (using quantitative approaches) or
subjective (using more intuitive or qualitative approaches), depending on what data is available
and the distance into the future for which a forecast is desired. Forecasting approaches will
typically be more objective for nearer term forecasting horizons and for events where there is
plenty of quantitative data available. More distant time periods, or events with a lack of historical
quantitative data will often call for more subjective approaches. We will discuss these two classes
of forecasting methods, and the categories within each.

Objective Forecasting Approaches

Objective forecasting approaches are quantitative in nature and lend themselves well to an
abundance of data. There are three categories of objective forecasting methods: time series,
causal/econometric, and artificial intelligence. AI approaches are outside my experience, so I
won’t be covering them in this series, but mention them as another alternative, in case you wish to
investigate them on your own.

Time Series Methods

Time series methods attempt to estimate future outcomes on the basis of historical data. In many
cases, prior sales of a product can be a good predictor of upcoming sales because of prior period
marketing efforts, repeat business, brand awareness, and other factors. When an analyst
employs time series methods, he/she is assuming that the future will continue to look like the
past. In rapidly changing industries or environments, time series forecasts are not ideal, and may
be useless.

Because time series data are historical, they exhibit four components that emerge over time:
trend, seasonal, cyclical, and random (or irregular). Before any forecasting is done on time series
data, the data must be adjusted for each of these components. Decomposing time series data will
be discussed later in this series.

The most common time series methods include moving average (both straight and weighted),
exponential smoothing, and regression analysis. Each of these approaches will be discussed later
in the series.
Causal/Econometric Methods

Causal or econometric forecasting methods attempt to predict outcomes based on changes in

factors that are known – or believed – to impact those outcomes. For example, temperature may
be used to forecast sales of ice cream; advertising expenditures may be used to predict sales; or
the unemployment rate might be used to forecast the incidence of crime in a neighborhood. It is
important to note, however, that just because a model finds two events that are correlated (e.g.,
occur together), it does not necessarily mean that one event has caused the other.

Regression analysis also falls under the causal/econometric umbrella, as it can be used to predict
an outcome based on changes in other factors (e.g., SAT score may be used to measure likelihood
of being accepted to a college). Econometric forecasting methods include Autoregressive Moving
Average (ARMA) and Autoregressive Integrated Moving Average (ARIMA) models. ARIMA was
previously known as Box-Jenkins. ARMA and ARIMA models are used in certain cases, but most
of the time are unnecessary. Although these two methods won’t be covered in much depth later
in the series, there will be a brief description of them and when they are needed.

Subjective Forecasting Approaches

Subjective forecasts are more qualitative. These approaches rely most heavily on judgment and
educated guesses, since there is little data available for forecasting. This is especially the case in
long-range forecasting. It’s easy to forecast next week’s sales of ice cream – and possibly
even of individual flavors, since you’ll likely have months or years of past weekly ice cream sales
data. However, if you’re trying to get an idea of what ice cream consumption or flavor preferences
will be 10 years from now, quantitative approaches will be of little use. Changes
in tastes, technology, and political, economic, and social factors occur and can dramatically alter
the course of trends. Hence, the opinion of subject matter experts is often called upon. There is
essentially only one category of subjective forecast approaches – and it is rightly called
“Judgmental” forecasts.

Judgmental Methods

Judgmental forecasting methods rely much on expert opinion and educated guesses. But
just because they have little quantitative or objective basis doesn’t mean they should be dismissed
or not measured for accuracy. The most common types of of judgmental forecasting methods are
composite forecasts, extrapolation, surveys, Delphi method, scenario writing, and
simulation. Each of these methods will be discussed in detail later in the series.

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