Forecasting

Definition
A forecasting is an estimation of an event which will happen in future.
• The event may be demand of a product, rainfall at a particular place, population
of the country or growth of technology.

• In industry, forecasting is the first level of decision activity.

• Estimation of demand for a particular product.
• The primary goal of OM is to match supply to demand.
• Forecasting demand is essential for how much capacity or supply needed to meet demand.

Forecasting has two aspects:

• Expected level of demand – Structural variation, trend , sessional

• The degree of accuracy that can assigned to a forecasting

Time horizon:

• Short range forecasting- an hour, day, week or up to month) –on going operations:
job scheduling, work force levels, job assignment, production level
• Medium range forecasting- time span one to three years: sales planning,
production planning, cash budgeting
• Long range forecasting-three years, five years or more years: the life of the product,
new product development, new facility, facility location, research and development

Forecasting Process:

1. Determine what to forecast: decide whether to forecast unit sales, $ sales, total sales,
sales by production line, domestic sales, sales in region
2. Identify time dimensions: length and period of forecasting- annual,
a quarterly, a month, a weekly, daily basis

3. Data Considerations: Quantity and the type of data that are available for forecasting.
- Internally, Externally
- Some date are not retained for use of forecasting. How frequently date
are kept: annual basis, quarterly basis, monthly basis, day basis.

4. Model selection: Depend of number of criteria

(i) The demand pattern
(ii) The quantity of historical data available
(iii) The length of the forecasting horizon
Forecasting method, data pattern, quantity of data, forecast horizon
5. Model evaluation: the result fit with historical data, error calculation, accuracy.
When the sufficient data is available, use a “ holdout” period to evaluate forecast accuracy.
If the model did not an acceptable level of accuracy, go to step no 5 and select an alternate
model.

6. Forecast Preparation: Some methods or set of methods are used for developing the forecast.
Prepare a worst-case , a best case and most-likely forecast. Combination of all forecasting
result for get a better forecast.

7. Forecast presentation: Presentation of forecast results

8.Tracking result: Continuous tracking of how well forecast compare with actual values,
deviation from forecast and actual events should discuss and understand the errors occurred.
 Time Series Data and Demand Patterns

• The data that are used most often in forecasting are time series.
• A time series is a set of numerical values of some variable obtained at regular period
over the time.
• The series usually tabulated or graphed and understand the behavior of the variable.

Example: Sales data by month from January 2009 to December 2016

No of visitors to a national park last year
Stock price daily basis

Objectives of Time Series Analysis:

• Some underline patterns exists in historical data.
• Objective to identify the pattern and influencing factors for prediction for future
planning and control.
 Time Series Patterns

Actual value of the variable at time t = mean value at time t + random deviation from mean value

Y = pattern(mean) + ɛ (noise)

Demand Patterns

Historical Pattern:
This exist where there is trend in data when the mean value does not change over time.

Trend: Time series display either increasing or decreasing in the average values
of the forecasting variable over the time. Sales of products, stock price.
Cycles:
Wavelike upward and downward movement of the date about the trend time over a
period of time.
Price of metals, gross national products

Seasonal:
It is a special case of a cycle in which fluctuations are repeated usually within a year.
Sales of soft drink, sales of refrigerators, sales of wool items

Irregular:
Random fluctuations and most difficult to capture in the forecasting model.
 Forecasting Models

The forecasting techniques can be classified into quantitative techniques and

qualitative techniques.

Quantitative techniques --- Historical data

Qualitative techniques --- Subjective approaches

 Quantitative Forecasting Techniques

• Simple moving average

• Weighted moving average
• Simple exponential smoothing
• Exponential smoothing with linear trend
• Simple regression
• Seasonal index model
 Qualitative Techniques

• Delphi method
• Market Research
 Simple Moving Average:
The moving averages which serve as an estimate of the next period’s value of a variable
given a period of length n.
OR
SMA is a method of computing the average of a specified number of the most recent data
value in a series.

Moving average

Mat = {Dt – (n-1)+Dt –(n-2)+….+ Dt-2+Dt-1 + Dt}/n

Where Mt – Simple moving average at the end of period t

(It is to be used as a forecasting for period t+1)
Dt – Actual demand in period t
n- Number of periods
Ft+1- forecast for period t+1
• A manufacturer of television has the following data pertaining the actual demand for television
(in thousands) during in a year. Use the three-time moving average method to forecast the
demand of next year month of January.
Time Demand Moving Forecast Ft
Month (t) Month (t) Average Mt

1 95
2 100
3 87
4 123
5 90
6 96
7 75
8 78
9 106
10 104
11 89
12 83

Forecast for period of 13 month.

 Weighted Moving Average
•Equal weights were assigned to all period in a simple moving average.
•In some demand value weighted given more than others.

Problem
In the table for a three months weighted moving average with a weight of 0.5 assigned
to the most recent demand value, 0.30 assigned to the next most recent value and 0.20
assigned to the oldest of the demand value. Forecast the demand for period 7.

Time (t) Demand MA Forecast

1 120
2 130
3 110 118
4 140 129 118
5 110 119 129
6 130 126 119
Weight MA3 = (0.2x120 + 0.3x 130 + 0.5x 110)/(0.2+0.3+0.5)
=118

Weight Mai = ∑wiDi/ ∑wi

 Exponential Smoothing Method
Ft = Ft-1 +α (Dt-1 – Ft-1)

Ft = αDt-1 + (1- α)Ft-1

Where Ft= current period forecast

Ft-1= last period forecast
α = a weight called smoothing constant
(0 ≤ α ≤1)
Dt-1= last period actual demand

•If α = 0, Ft = Ft-1
The new base is just same as previous base (Average)
•If α = 1, Ft= Dt-1
The new base is the previous period demand.
If the value of α is small are smooth and fluctuation is less.
•It is the sophisticated weighted moving average

•ESM use for forecasting for a large number of items.

•The forecasting horizon is relatively short i.e. daily, weekly or monthly demand.

•ESM model is applicable when there is no trend or seasonality component in the data.

•Demand fluctuation around an average demand which is called “base”.

•It keep on running average demand and adjust it for each period in proportion to the
difference between the latest actual demand figure and the latest value of the average.
 Problem

A firm uses simple exponential smoothing with α = 0.2 to forecast demand. The
forecast for the first week of January was 400 units, where as the actual demand
turned out to be 450 units:

a) Forecast the demand for the second week of January.

a) Assume that the actual demand during the second week of January turned out to
be 460 units. Forecast the demand up to February fourth week, assuming the
sequence demand as 465,434, 420, 498 and 462 units.
Forecast of second week of January:

Ft= αDt-1 + (1-α) Ft-1

F2 = 0.2x450 + 0.8 x 400

= 410 units
Week Demand old forecast new forecast
Dt-1 Ft-1 Ft= αDt-1 + (1-α)Ft-1
Jan 1 450 400 410
Jan 2 460 410 420
Jan 3 465 420 429
Jan 4 434 429 430

Feb 1 420 430 428

Feb 2 498 428 442
Feb 3 462 442 446
 Forecasting Error
•Demand forecast influences most of the decisions in all functions.
•It must be estimated with the highest level of precision.
•Accuracy and control of forecasting is a vital aspects of forecasting.
•Decision makers will want to include accuracy as a factor.
•The measure may be a aggregate error (deviation) of the forecasting values from the
actual demand.

Error= actual- forecast

Et = Dt – Ft

t= time period
MAD= mean absolute deviation
MSE= mean squared error
MAPE= mean absolute percent error
MAD=∑|actual t – forecastt | /n

MSE= ∑(|actual t – forecastt | )2 /(n-1)

MAPE=∑{ (|actual t – forecastt |)/ actual t x 100}/n

Compute MAD, MSE, MAPE for the following data.

Period Actual Forecast

1 217 215
2 213 216
3 216 215
4 210 214
5 213 211
6 219 214
7 216 217
8 212 216
Period Actual Forecast Error |Error| Error*Error
1 217 215 2 2 4
2 213 216 -3 3 9
3 216 215 1 1 1
4 210 214 -4 4 16
5 213 211 2 2 4
6 219 214 5 5 25
7 216 217 -1 1 1
8 212 216 -4 4 16
Total -2 22 76
 Problem 2
Month Demand Forecast
1 150 165
2 160 165
3 165 170
4 175 180
5 180 165
6 182 174
7 176 182
8 181 167
9 164 170
10 155 163
11 162 168
12 170 174

Find MAD, MSE, MAPE?

 Exponential Smoothing with Linear Trend Model
•The Simple ESM forecast is a smoothing average position on the current period.

•In reality, trend exits in the demand pattern of many business.

•Adjusted ESM is projects the next period forecast by adding a trend component to the
current period forecast Ft

•Ft =αDt-1 + (1-α) (Ft-1 + Tt-1 )

•Tt = β(Ft –Ft-1 )+ (1-β) Tt-1
•Ft+1 = Ft + T t
α and β are smoothing constants
Example:
Compute the linear or trend ESM forecast for the first week of March for a firm with
the following data. Assume forecast for the first week of January(F0) as 600 and
Corresponding initial trend (T0) is 0. Let α =0.1 and β=0.2
Week Demand
January 1 650
January 2 600
January 3 550
January 4 650

February 1 625
February 2 675
February 3 700
February 4 710

Forecast for first week of March.

 Linear Regression :

The relationship between a dependent y and only one independent

variable x, then such model is called a simple regression model.

Y = a+ bX

Y= dependent variable
X= independent variable
a= y- intercept
b= slope (trend)

XY – nXY
a = Y – bX b=
X 2 – nX 2
A firm believes that its annual profit depends on its expenditures
for research. The information for the preceding six years is given
below:

Year Expenditure for research (x)Lac Annual profit (y)Lac

1 2 20
2 3 25
3 5 34
4 4 30
5 11 40
6 5 31

Forecast the profit for 7th year when the expenditure is 6 lac.

Appling the formula you will get the value of b=2 and a= 20

Y= 20 + 2x
= 20 + 2 (6) = 32 lac
The profit on 7th year when the expenditure is 6 lac will be 32 lac.
The advertisement expenditure and the actual sales (in thousand) for five months
is given below. Using regression analysis forecast the sales for advertisement
expenditure is 2.3 thousand $.

Sales Advertising
Month (000 units) (000 $)

1 264 2.5
2 116 1.3
3 165 1.4
4 101 1.0
5 209 2.0
Problem:

Alpha company has the following sales pattern. Compute the sales forecasting for
the year 10.
Year 1 2 3 4 5 6 7 8 9
Sales 6 8 11 23 29 34 40 45 56
(in lacs)
 Delphi Method

•It is used as long term prediction.

•The objective of Delphi method is to probe into the future in hopes of
new products and processes on the rapid change of environment of today culture and
economy.
•In the short range, Delphi method can also be used to estimate market size and timing.

•Examine the development of computer languages- prediction of fifth generation

•Several knowledge persons are asked to provide subjective estimates of demand or

forecasting of possible advances of technology.
•The experts may provide several opinions. Based on the opinions arrived at the demand
of product/advance tech.
•Panel members must be unknown to each other.
•The initial questionnaire should be unambiguous and it should explain every matter.

•After getting the opinions from the panel members they are to be compared for
similarity.
•If the variation among the opinion is too much, the summary is to be circulated again
among the members and again provide for opinions.
•Generally 50% of the estimate is treated as the basis for comparison.
•The panel members whose opinions differ significantly from the middle of 50% of the
estimate will asked for the reconsider their opinions.
•Still, if they want to stick to their original opinions they will be asked to provide rationale
for the same.

•Delphi method is an iterative process, until the panel converges on the specific value
or range of values as defined by the required accuracy or arrives at point under
considerations.
 Marketing Research

 Primary Research

 Surveys
• Interviews
• Observations
• Experiment, field project

 Secondary Research – From existing data