Operations Management, 20ME41P 2021-22

DEMAND FORECASTING
Steps in Demand Forecasting Process
1. Determine the Objective (Purpose) of the Forecast; Questions to be Answered are:
 What are the objectives of Forecast?
 When it is needed to be carried out?
2. Select the Item for which forecasting is needed, whether it is required for a single product or a group
of products.
3. Determine the tome for the forecast; whether short-range, medium-range or long-range.
4. Select the forecasting model (method/technique); whether to use statistical (quantitative) models or
qualitative techniques.
5. Gather & analyse the data needed for the forecast.
6. Prepare the forecasting using the selected method.
7. Monitor the forecasting to make sure that it is being done as per the plan and review it, if necessary.
Methods of Demand Forecasting
Demand forecasting is classified into two types...
a) Quantitative methods and
b) Qualitative methods.
Quantitative Methods of Demand Forecasting
There are five quantitative forecasting methods and all these methods use historical data.
These five methods can be put under two categories...
1) Time Series Models
a) Naive Approach
b) Moving Averages Method
c) Exponential Smoothing Method
2) Casual Models
a) Trend Projection
b) Linear Regression Analysis
Time Series Models
 Time series models are also called extrapolative methods using time series.
 These are the easiest methods of forecasting.
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 If previous data is all linear, then extrapolation is simple & easy.

 For e.g., demand for previous three years is 85, 90, & 95, then demand forecast for the coming year
can be expected to be 100.
 However, if previous years’ data shows upward & downward swings, then, an average taken over a
number of past years or time series is more reliable as a forecast for the future year.
 A time series is a time ordered sequence of observations taken at regular intervals over a period of
time.
 Sequence of observations could be hourly, daily, weekly, monthly, quarterly, semi-annually or
annually.
 Historical data may contain random variation called noise that tends to observe systematic
movement in the data.
 One should completely remove such randomness from the data & should leave only the real
variation such as changes in demand.
 Averaging techniques generate forecasts that reflect recent values of a time series.
The three techniques of averaging are as follows...
a) Naive Approach
b) Moving Averages Method
c) Exponential Smoothing Method
Naive Approach
 It is the simplest way to forecast.
 Here the forecast of demand for the next period is assumed to be equal to the actual demand in the
most recent (current) period.
 For e.g., if the actual sales for June 2021 is 500 units, then the forecast demand for July 2021
will also be 500 units.
Moving Averages Method
 Moving average forecast uses a number of most recent historical actual data values to generate a
forecast.
 Simple moving average method is used to estimate the average of a demand time series & remove
the effects of a random fluctuation. This is the most useful technique when demand has no trend or
has seasonal fluctuations.

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 In weighted moving average method, each historical demand data in moving average will have its
own weight where the sum of all the weights equals one; usually, the most recent demand data is
assigned highest weight. Therefore, benefit of weighted moving average is that it allows to high light
recent data over earlier data.
Exponential Smoothing Method
It is a sophisticated weighted moving average method, relatively easy to understand & use. It requires
only three items of data:
a) This period’s forecast.
b) Actual demand for this period and
c) Having a value between 0 & 1 referred to as smoothing constant.
Here Next Period’s Forecast = This Period’s Forecast + α (This Period’s Actual Demand – This
Period’s Forecast). Selecting value for α or smoothing constant is basically a matter of judgement or
based on trial & error.
Casual Models
 According to causal methods of forecasting, demand is dependent variable & other factors that
affect demand are independent variables or causal variables.
 In other words, causal models incorporate variables or factors that might influence the quantity
being forecast.
Important Causal Methods of forecasting are as follows...
a) Trend Projection
b) Linear Regression Analysis
Trend Projection
 The method is also known as Least Square Method.
 According to this method, a large amount of reliable data is required for demand forecasting.
 The method assumes that factors responsible for past trends such as sales or demand would
remain the same in future under normal conditions.
Linear Regression Analysis
 It is a set of statistical methods used for the estimation of relationship between two variables.
 A dependent variable (demand) & one or more independent variables.

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 In linear regression analysis, both independent & dependent variables change by the same
proportion.
 For e.g., 10 % increase in disposable income (income remaining after deduction of taxes) of people
(independent variable) will cause 10 % increase in demand (dependent variable) for the product
under consideration.
Multiple Choice Questions (MCQ’s)
1) Quantitative method of demand forecasting include ___________
a) Naïve approach
b) Moving averages method
c) Both a and b
d) Neither a nor b
2) Naïve approach comes under ___________
a) Time series model
b) Casual method
c) Neither a nor b
d) Both a and b
3) Moving averages method comes under ___________
a) Casual method
b) Time series model
c) Neither a nor b
d) Both a and b
4) Exponential smoothing method comes under ___________
a) Casual method
b) Time series model
c) Neither a nor b
d) Both a and b
5) Trend projection comes under ___________
a) Casual method
b) Time series model
c) Neither a nor b
d) Both a and b
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6) Linear regression analysis comes under ___________

a) Time series model
b) Casual method
c) Neither a nor b
d) Both a and b
7) Time series models are also called as ___________
a) Exponential smoothing method
b) Extrapolative methods
c) Casual models
d) Both a and c
8) In ___________ method forecast of demand for the next period is assumed to be equal to actual
demand in the current period.
a) Naive
b) Moving averages
c) Exponential smoothing
d) Weighted moving average
9) ___________ method is used to estimate the average of a demand time series and remove the
effects of random fluctuation
a) Naive
b) Weighted moving average
c) Simple moving average
d) Exponential smoothing
10) Exponential smoothing requires __________
a) This periods forecasting
b) Actual demand for this period
c) Smoothing constant
d) All of the above
11) Trend projection method is also called as __________
a) Simple average method
b) Exponential smoothing method
c) Sales force composite method

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d) Least square method

12) In linear regression analysis dependent and independent variables change by __________ proportion
a) Same
b) Different
c) Mixed
d) None of the above

Q
1 2 3 4 5 6 7 8 9 10 11 12
No
Ans c a b b a b b a c d d a

Descriptive Questions
Remember
1) List the steps in demand forecasting process.
2) List the quantitative methods of demand forecasting.
3) List four qualitative methods of demand forecasting.
Understanding
1) Explain Naive approach, simple moving average method, weighted moving average method and
exponential smoothing method, briefly?
2) Explain trend projection and linear regression, briefly?

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