OPERATIONS MANAGEMENT

FORECASTING
What is Forecasting?

Forecasting is the art and science of predicting future events. (General definition)

In the context of operations management, forecasting involves finding the probable demand for a
product or service and forms the basis of all business decisions, like:
 Production planning
 Inventory management
 Personnel planning
 Facilities management
 Scheduling of operations

Forecasting may involve taking historical data and projecting them into the future with some sort
of mathematical model. It may be a subjective or intuitive prediction. Or it may involve a
combination of these—that is, a mathematical model adjusted by a manager’s good judgment.
Good forecasts are of critical importance in all aspects of a business: The forecast is the only
estimate of demand until actual demand becomes known. Forecasts of demand therefore drive
decisions in many areas like (1) human resources, (2) capacity, and (3) supply-chain
management.

 Forecasts are seldom perfect. This means that outside factors that we cannot predict or
control often impact the forecast. Companies need to allow for this reality.
 Most forecasting techniques assume that there is some underlying stability in the system.
 Both product family and aggregated forecasts are more accurate than individual product
forecasts

Few businesses can afford to avoid the process of forecasting by just waiting to see what happens
and then taking their chances. However, effective planning in both the short run and long run
depends on a forecast of demand for the company’s products.

Why forecasting is done?

 Forecasting the demand is the first step before setting up the operations.
 Forecasting helps managers and decision makers to develop appropriate plans and reduce
uncertainty of events in the future.
 Managers want to know the demand so that they can match supply with demand and ensure
profitable business.
 Without knowing the demand operational processes would not have proper direction or
goal to start the activities.
 All the resource planning completely depends on knowing the demand, and hence
forecasting is essential.

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The questions are:
1. How to forecast?
2. How frequently?
3. Forecasting for what future period
4. How to check the accuracy of forecast?
5. What are the different methods available for forecasting?
6. How to develop forecasting models?

Is demand forecasting just generating a number?

No, output of forecast includes two numbers:

1) Best estimate of the demand, and
2) Allowance or error

Therefore, actual decision based on forecasting includes decision assuming forecast is correct
and allowance for forecast error. Because forecasting, no matter which method was followed,
will rarely be accurate. This is because no model can predict the uncertainties and unexpected
events which affect the forecast values. Hence it is essential to use managerial judgement and
knowledge gained from new observations to improve or modify the forecast as shown in the
Figure 1.

Figure 1. Towards a better forecast

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Further it is essential to remember the cost implications of forecasting. Any method of
forecasting consumes resources like technology, people, energy, time, and knowledge, which all
will add cost to the forecasting process. This can be called as the cost of forecasting and some
cost would always be incurred in forecasting by whatever method chosen. Further, to improve
the accuracy of forecasting, more cost would be spent which makes the process more expensive.
On the other hand, if forecasting is not done, there is always an uncertainty and it would cost
high because of decisions based on only guesswork or random choice. Thus the question would
be how to balance the cost of forecasting against the losses that may occur for not forecasting
and leading to wrong projections. This is illustrated in Figure 2.

Figure 2. Cost implications of forecasting

What are to be considered for forecasting?

 Input elements involved
 Process generating the variable
 Availability of data
 Stability of the process
 Accuracy of data
 Adequacy of data
 Representativeness of the data

Forecasting Time Horizons

A forecast is usually classified by the future time horizon that it covers. Time horizons fall into
three categories:
1. Short-range forecast: This forecast has a time span of up to 1 year but is generally less
than 3 months. It is used for planning purchasing, job scheduling, workforce levels, job
assignments, and production levels.
2. Medium-range forecast: A medium-range, or intermediate, forecast generally spans from
3 months to 3 years. It is useful in sales planning, production planning and budgeting,
cash budgeting, and analysis of various operating plans.

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 3. Long-range forecast: Generally, 3 years or more in time span, long-range forecasts are
used in planning for new products, capital expenditures, facility location or expansion,
and research and development.

The Influence of Product Life Cycle

Another factor to consider when developing sales forecasts, especially longer ones, is product
life cycle. Products, and even services, do not sell at a constant level throughout their lives. Most
successful products pass through four stages: (1) introduction, (2) growth, (3) maturity, and (4)
decline. Products in the first two stages of the life cycle (such as virtual reality and LCD TVs)
need longer forecasts than those in the maturity and decline stages (such as 3.5" floppy disks and
skate

THE STRATEGIC IMPORTANCE OF FORECASTING

Good forecasts are of critical importance in all aspects of a business: The forecast is the only
estimate of demand until actual demand becomes known. Forecasts of demand therefore drive
decisions in many areas for example (1) human resources, (2) capacity, and (3) supply-chain
management.

SEVEN STEPS IN THE FORECASTING SYSTEM

Forecasting follows seven basic steps. We use Disney World as an example of each step:
1. Determine the use of the forecast: Disney uses park attendance forecasts to drive staffing,
opening times, ride availability, and food supplies.
2. Select the items to be forecasted: For Disney World, there are six main parks. A forecast
of daily attendance at each is the main number that determines labor, maintenance, and
scheduling.
3. Determine the time horizon of the forecast: Is it short, medium, or long term? Disney
develops daily, weekly, monthly, annual, and 5-year forecasts.
4. Select the forecasting model(s): Disney uses a variety of statistical models that we shall
discuss, including moving averages, econometrics, and regression analysis. It also
employs judgmental, or non-quantitative, models.
5. Gather the data needed to make the forecast: Disney’s forecasting team employs 35
analysts and 70 field personnel to survey 1 million people/businesses every year. It also
uses a firm called Global Insights for travel industry forecasts and gathers data on
exchange rates, arrivals into the U.S., airline specials, Wall Street trends, and school
vacation schedules.
6. Make the forecast.
7. Validate and implement the results: At Disney, forecasts are reviewed daily at the highest
levels to make sure that the model, assumptions, and data are valid. Error measures are
applied; then the forecasts are used to schedule personnel down to 15-minute intervals.

These seven steps present a systematic way of initiating, designing, and implementing a
forecasting system. When the system is to be used to generate forecasts regularly over time, data
must be routinely collected. Then actual computations are usually made by computer.

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Regardless of the system that firms like Disney use, each company faces several realities:
1. Forecasts are seldom perfect. This means that outside factors that we cannot predict or
control often impact the forecast. Companies need to allow for this reality.
2. Most forecasting techniques assume that there is some underlying stability in the system.
Consequently, some firms automate their predictions using computerized forecasting
software, and closely monitor only the product items whose demand is erratic.
3. Both product family and aggregated forecasts are more accurate than individual product
forecasts. Disney, for example, aggregates daily attendance forecasts by park. This
approach helps balance the over- and under-predictions of each of the six attractions.

TYPES OF FORECASTS
Organizations use three major types of forecasts in planning future operations:
1. Economic forecasts address the business cycle by predicting inflation rates, money
supplies, housing starts, and other planning indicators.
2. Technological forecasts are concerned with rates of technological progress, which can
result in the birth of exciting new products, requiring new plants and equipment.
3. Demand forecasts are projections of demand for a company’s products or services.
These forecasts, also called sales forecasts, drive a company’s production, capacity, and
scheduling systems and serve as inputs to financial, marketing, and personnel planning.

Classification of forecasting methods

Based on the type of database

 Quantitative (Statistical forecasting)
 Qualitative (Subjective estimation)

Based on the forecast time period

 Short range – up to 1 year
 Medium range – 1 to 3 years
 Long range – 5 years or more

Based on the methodology

 Time – series methods
 Causal methods
 Predictive methods (Qualitative methods)

Major methods of forecasting based on the type of database

Qualitative methods
These methods involve intuition, judgement, and experience, and are used -
 When situation is vague and little data exist
 When launching new products
 When adopting new technology
e.g., forecasting sales on Internet

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Different qualitative methods are:
 Market surveys
 Nominal group testing
 Historical analysis
 Life cycle analysis
 Informal Judgments
 Delphi method

Quantitative methods
Quantitative methods involve mathematical models and are used when situation is ‘stable’ and
historical data exist. Stability refers to data not showing too many fluctuations and thus makes it
easy to project for future periods. These methods are used for existing products, and current
technology, where good amount of data is available, for example, forecasting sales of color
televisions

Quantitative methods can be categorized as follows:

Time Series Methods Causal methods

 Moving averages  Regression analysis
 Exponential Moving averages  Input – output model
 Box – Jenkins method  Leading indicators
 Trend projections  Simulations model
 Fourier Series  Economic models

How to select the method of forecasting?

Whichever method of forecasting that would give reliable values would obviously be the choice
Selection of the forecasting method is based on:

 Form of forecast required

 Forecast horizon, period, and interval
 Data availability
 Accuracy required
 Behavior of process being forecast (demand pattern)
 Cost of development, installation, and operation
 Ease of operation
 Management comprehension and cooperation.

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 Figure 3. Selecting the method of forecasting.
Case Study: Forecasting by “Titan Industries”
Titan Industries is India’s leading manufacturer of watches and jewelry and the world’s sixth
largest manufacturer brand of watches. Established in 1984 as a joint venture between the Tata
Group and the Tamil Nadu Industrial Development Corporation, the company transformed the
Indian watch market, offering quartz technology with international styling, manufactured at its
state-of-the-art factory at Hosur, Tamil Nadu. In 1995, the company diversified into jewelry
under the brand Tanishq.
Leveraging its understanding of different segments in the watch market, the company launched a
second independent watch brand — Sonata — as a value brand to those seeking to buy
functionally styled watches at affordable prices. It also entered the segment of premium fashion
watches by acquiring a license for global brands such as Tommy Hilfiger. Titan has also
diversified into fashion eyewear with its Fastrack Eye Gear sunglasses. Further, Titan leveraged
its manufacturing competencies and branched into precision engineering products and machine
building in 2003.
Titan manufactures over 7 million watches per annum and has a customer base of over 65
million. The company has manufacturing and assembly operations at Hosur, Dehradun and
Himachal Pradesh. Its main products are:

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Watches: Titan manufactures two main brands viz. Titan for the premium segment and Sonata
for the below-$25 category. The Titan brand architecture comprises several brands, each of
which is a leader in its segment. Notable among them are: Titan Edge – the world’s slimmest
watch; Nebula – in solid gold and precious stones; the Gold and Steel collection; Raga 9 to 5 –
for the woman achiever; Flip – India’s first and only reversible watch with two movements and
dial faces; and Fastrack in the sporty casual category.
Jeweler: Tanishq is India’s largest and fastest growing jewelry brand. Tanishq has 75 boutiques
in 55 cities across the country with a
premium range of gold jewelry studded with diamonds or colored gems and a wide range in 22kt
pure gold. Platinum jewelry and
designer silverware are also a part of the product range. Tanishq is one of India’s largest
specialty retailers and is transforming the jewelry market in India.
Precision engineering: The company’s precision engineering division manufactures dashboard
clocks as OEM to car manufacturers in Europe and America. It also supplies precision
components to the avionics and the automotive industry.
Forecasting demand
Securing the future of a Titan product is a scientific and rigorous exercise. To accurately predict
which watch the market needs and in what quantity, Titan uses a time-tested method. First, it
studies the historic sales of different styles. The primary information comes from an account of
its own sales. Retail or secondary information is gathered from showrooms and distributors. The
company also keeps in mind elements such as marketing schemes and advertisement campaigns
to foresee demand. Seasonality is factored in because sales shoot up during festivals like Diwali,
Onam and Pongal.
Considering that there are about 1,300 variants in the domestic market and 700 internationally,
there is a lot of estimating to do. Instead of forecasting for all its varieties, Titan focuses on about
400 variants that contribute to 75 per cent of the company's overall sales.
To hit on the optimal mix of products, the company has also come up with an iterative demand-
planning method. It is currently setting up an 'advanced planning and optimizing' (APO) tool.
This monster of an engine takes into account the historic sales pattern for three years and applies
a forecasting model to that data and develops a heuristic. The forecast thrown up by this formula
is then vetted by the sales and marketing group, which may want to modify it based on specific
sales or market inputs they have received.
[Source: http://www.tata.com/titan/articles/20050630_supply.htm]

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