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 The Fundamental Elements of Forecasting in Operations Management

The Fundamental Elements of

Forecasting in Operations
Management
RELATED BOOK
Operations Management For Dummies

By Mary Ann Anderson, MSE, Edward J. Anderson, Geoffrey Parker

Point forecasts, or single-number predictions of demand, are generally always incorrect. You want
an accurate forecast to inform your operations management. That’s why you need not only an
expected value (what you think demand will be) but also a measure of your method’s forecasting
error.

Here are the fundamental tenets of forecasting:

Aggregated forecasts are more accurate than disaggregated forecasts. Forecasting the
demand for a product at a national level is more accurate than forecasting it at each individual
retail outlet. The variation of demand at each sales point is smoothed when aggregated with
other locations, providing a more accurate prediction. You can achieve a similar improvement
by forecasting the aggregate demand for all the variations of a product combined.

Be prepared to change your forecasting model, but don’t overreact to random

changes. Demand patterns can and do change, and when actual changes occur, you may
need to change your forecasting technique. Measuring your forecasting error can alert you
when changes occur; however, you need to verify that a sustainable change has actually
occurred and that what you observed isn’t a random variation.

Don’t substitute forecasts for known information. Many companies can become blinded
by their forecast and ignore what’s actually occurring in the business environment. If
something changes, such as a weather occurrence, or more data becomes available, such as a
sales order, be prepared to adjust your forecast to incorporate the new information.

If a simple technique yields acceptable accuracy, don’t use a more advanced

technique. Use the simplest forecasting model that provides the desired accuracy. For
example, don’t use a model for seasonality unless it gives you noticeably greater accuracy than
a simple exponential smoothing model.

Select a forecasting technique that makes good use of the available data. The time-
series forecasting methods rely on having not only a large quantity of data but also relevant
and accurate data. If you don’t have con dence in the amount or quality of the data, you may
want to choose a qualitative method to forecast until data becomes available.

For example, consider basing your forecasts on potential market size and adjusting based on
experience. Applying sophisticated forecasting models to faulty data won’t improve the
underlying quality of the data or the forecast.

Short-term forecasts are more reliable than long-term forecasts. The forecast horizon,
or how long into the future the forecast predicts, has a direct impact on accuracy. In other
words, predicting the sales for this month is easier than predicting the sales for a year from
now.

Many things can happen between now and next year, such as new competitors entering the
market, customer preferences changing, or new technology causing shifts in demand. These
changes become tougher to predict as the forecast horizon increases.

There is no single best forecasting technique. The important point is to compare di erent
forecasting models and choose the one that best meets the needs of your situation and
matches the data you have available.
It’s important to note that, although disaggregate forecasts can be less accurate than aggregate
forecasts, disaggregate forecasts are critical to production planning. For example, if a rm
produces di erent models of TVs, production planning at the manufacturing oor level requires a
detailed number of how many of each model to produce.

By postponing a commitment to the details, the rm can make a more accurate disaggregate
forecast (short-term forecasts are more accurate than long-term forecasts). Reducing ow
times allows a rm to delay the decision on what exact models to produce, which improves
its forecasts.