Chapter 3: Forecasting

BME 15 Operations Management

Review Guide

1. A forecast is an estimate about the future value of a variable such as demand.

2. Forecasts help managers by reducing some of the uncertainty - forecasts are vital inputs for the
design and the operation of the productive systems because they help managers anticipate the
future.
3. Usefulness of forecasts in the various functional departments of a business organization:
a. Accounting. New product/process cost estimates, profit projections, cash management.
b. Finance. Equipment/equipment replacement needs, timing and amount of
funding/borrowing needs.
c. Human resources. Hiring activities, including recruitment, interviewing, and training;
layoff planning, including outplacement counseling. more meaningful plans.
d. MIS. New/revised information systems, internet services.
e. Operations. Schedules, capacity planning, work assignments and workloads, inventory
planning, make-or-buy decisions, outsourcing, project management.
f. Product/service design. Revision of current features, design of new products or services
4. Forecasts are also used to predict profits, revenues, costs, productivity changes, prices and
availability of energy and raw materials, interest rates, movements of key economic indicators
(e.g., gross domestic product, inflation, government borrowing), and prices of stocks and bonds.
5. There are six basic steps in the forecasting process:
a. Determine the purpose of the forecast. How will it be used and when will it be needed?
b. Establish a time horizon. The forecast must indicate a time interval, keeping in mind that
accuracy decreases as the time horizon increases.
c. Obtain, clean, and analyze appropriate data. Obtaining the data can involve significant
effort.
d. Select a forecasting technique.
e. Make the forecast.
f. Monitor the forecast errors - to determine if the forecast is performing in a satisfactory
manner.
g. Reexamine the method, assumptions, the validity of data, and so on; modify as needed;
and prepare a revised forecast
6. Forecasting techniques can be classified as qualitative or quantitative.
7. Trending techniques generally assume that the same underlying causal system that existed in
the past will continue to exist in the future.
8. The qualitative techniques include consumer surveys, salesforce estimates, executive opinions,
and manager and staff opinions.
9. Two major quantitative approaches are described: analysis of time-series data and associative
techniques.
10. Time-series techniques rely strictly on the examination of historical data; predictions are made
by projecting past movements of a variable into the future without considering specific factors
that might influence the variable.
11. Associative techniques attempt to explicitly identify influencing factors and to incorporate that
information into equations that can be used for predictive purposes.
12. Control of forecasts involves deciding whether a forecast is performing adequately, typically
using a control chart.
13. Qualitative techniques rely on judgment, experience, and expertise to formulate forecasts:
a. Executive Opinions
b. Salesforce Opinions
c. Consumer Surveys
14. Quantitative techniques rely on the use of historical data or associations among variables to
develop forecasts.
15. Classification of forecasting techniques as judgmental, time-series, or associative.
16. Judgmental forecasts rely on analysis of subjective inputs obtained from various sources, such as
consumer surveys, the sales staff, managers and executives, and panels of experts.
17. Time-series forecasts simply attempt to project past experience into the future. These
techniques use historical data with the assumption that the future will be like the past.
a. Trend refers to a long-term upward or downward movement in the data.
Population shifts, changing incomes, and cultural changes often account for such
movements.
b. Seasonality refers to short-term, fairly regular variations generally related to factors
such as the calendar or time of day. Restaurants, supermarkets, and theaters experience
weekly and even daily “seasonal” variations.
c. Cycles are wavelike variations of more than one year’s duration. These are often related
to a variety of economic, political, and even agricultural conditions.
d. Irregular variations are due to unusual circumstances such as severe weather
conditions, strikes, or a major change in a product or service.
e. Random variations are residual variations that remain after all other behaviors have
been accounted for.
18. A naive forecast uses a single previous value of a time series as the basis of a forecast. One
weakness of the naive method is that the forecast just traces the actual data, with a lag of one
period; it does not smooth at all.
19. A moving average forecast uses a number of the most recent actual data values in generating a
forecast.
20. A weighted average is similar to a moving average, except that it typically assigns more weight
to the most recent values in a time series.
21. Exponential smoothing is a sophisticated weighted averaging method that is still relatively easy
to use and understand. Each new forecast is based on the previous forecast plus a percentage of
the difference between that forecast and the actual value of the series at that point.
22. Focus Forecasting Some companies use forecasts based on a “best recent performance” basis.
23. Associative models use equations that consist of one or more explanatory variables that can be
used to predict demand. For example, demand for paint might be related to variables such as
the price per gallon and the amount spent on advertising, as well as to specific characteristics of
the paint (e.g., drying time, ease of cleanup)
24. The essence of associative techniques is the development of an equation that summarizes the
effects of predictor variables. The primary method of analysis is known as regression.
25. Diffusion Models. These models take into account such factors as market potential, attention
from mass media, and word of mouth. Although the details are beyond the scope of this text, it
is important to point out that diffusion models are widely used in marketing and to assess the
merits of investing in new technologies. When new products or services are introduced,
historical data are not generally available on which to base forecasts. Instead, predictions are
 based on rates of product adoption and usage spread from other established products, using
mathematical diffusion models.
26. Simple Linear Regression The simplest and most widely used form of regression involves a linear
relationship between two variables.
27. Correlation measures the strength and direction of relationship between two variables.
Correlation can range from −1.00 to +1.00. A correlation of +1.00 indicates that changes in one
variable are always matched by changes in the other; a correlation of −1.00 indicates that
increases in one variable are matched by decreases in the other; and a correlation close to zero
indicates little linear relationship between two variables.
28. All forecasts include a certain degree of inaccuracy, and allowance should be made for this.
29. Forecast accuracy is a significant factor when deciding among forecasting alternatives. Accuracy
is based on the historical error performance.
30. Sources of inaccuracy may include
a. The forecast model may be inadequate due to
i. the omission of an important variable,
ii. a change or shift in the variable that the model cannot deal with (e.g., the
sudden appearance of a trend or cycle), or
iii. the appearance of a new variable (e.g., new competitor).
b. Irregular variations may occur due to severe weather or other natural phenomena,
temporary shortages or breakdowns, catastrophes, or similar events.
c. Random variations. Randomness is the inherent variation that remains in the data after
all causes of variation have been accounted for. There are always random variations.
31. Mean absolute deviation (MAD) - the average absolute forecast error.
32. Mean squared error (MSE) - the average of squared forecast errors.
33. Mean absolute percent error (MAPE) - the average absolute percent error.
34. Tracking signal - the ratio of cumulative forecast error to the corresponding value of MAD, used
to monitor a forecast.
35. Bias - persistent tendency for forecasts to be greater or less than the actual values of a time
series