FORECASTING

GROUP 6
CABEL, KARL AVERY
What is Forecasting in Operations Management?
• Operations management is complex: You have to plan, implement, and supervise the production of
goods and services. But forecasting can help smooth out the process by ensuring adequate resources to
meet demand. Organizations use forecasting methods to predict business outcomes. Forecasts create
estimates that can help managers develop and implement production strategies. Operations managers
are responsible for the processes that deliver the final product. This where forecasts can help: They aid
decision making and planning around possible events. The method of forecasting will vary according to
available data and industry size and respective goals. Forecasts are developed using both qualitative
and quantitative data. Although they are useful in making educated predictions, they are not always
accurate, so they should be used with caution.
 Forecasting

•  is the process of making predictions of the future based on past and present data. This is most
commonly by analysis of trends. A commonplace example might be estimation of some variable of
interest at some specified future date. Prediction is a similar, but more general term. Both might refer
to formal statistical methods employing time series, cross-sectional or longitudinal data, or
alternatively to less formal judgmental methods. Usage can differ between areas of application: for
example, in hydrology, the terms “forecast” and “forecasting” are sometimes reserved for estimates of
values at certain specific future times, while the term “prediction” is used for more general estimates,
such as the number of times floods will occur over a long period.
 Forecasting

• Risk and uncertainty are central to forecasting and prediction; it is generally considered good practice

to indicate the degree of uncertainty attached to specific forecasts. In any case, the data must be up to
date in order for the forecast to be as accurate as possible. In some cases, the data used to predict the
variable of interest is itself forecasted.

• As discussed in the previous chapter, functional strategies need to be aligned and supportive to the
higher level corporate strategy of the organization. One of these functional areas is marketing.
Creating marketing strategy is not a single event, nor is the implementation of marketing strategy
something only the marketing department has to worry about.
 Forecasting

• When the strategy is implemented, the rest of the company must be poised to deal with the consequences. An
important component in this implementation is the sales forecast, which is the estimate of how much the company
will actually sell. The rest of the company must then be geared up (or down) to meet that demand. In this module,
we explore forecasting in more detail, as there are many choices that can be made in developing a forecast.

• Accuracy is important when it comes to forecasts. If executives overestimate the demand for a product, the
company could end up spending money on manufacturing, distribution, and servicing activities it won’t need.
Data Impact, a software developer, recently overestimated the demand for one of its new products. Because the
sales of the product didn’t meet projections, Data Impact lacked the cash available to pay its vendors, utility
providers, and others. Employees had to be terminated in many areas of the firm to trim costs.
 Forecasting

• Underestimating demand can be just as devastating. When a company introduces a new product, it launches marketing and sales
campaigns to create demand for it. But if the company isn’t ready to deliver the amount of the product the market demands, then
other competitors can steal sales the firm might otherwise have captured. Sony’s inability to deliver the e-Reader in sufficient
numbers made Amazon’s Kindle more readily accepted in the market; other features then gave the Kindle an advantage that Sony
is finding difficult to overcome.

• The firm has to do more than just forecast the company’s sales. The process can be complex, because how much the company can
sell will depend on many factors such as how much the product will cost, how competitors will react, and so forth. Each of these
factors has to be taken into account in order to determine how much the company is likely to sell. As factors change, the forecast
has to change as well. Thus, a sales forecast is actually a composite of a number of estimates and has to be dynamic as those other
estimates change.
 Forecasting

• A common first step is to determine market potential, or total industry-wide sales expected in a particular product
category for the time period of interest. (The time period of interest might be the coming year, quarter, month, or
some other time period.) Some marketing research companies, such as Nielsen, Gartner, and others, estimate the
market potential for various products and then sell that research to companies that produce those products.

• Once the firm has an idea of the market potential, the company’s sales potential can be estimated. A firm’s sales
potential is the maximum total revenue it hopes to generate from a product or the number of units of it the company
can hope to sell. The sales potential for the product is typically represented as a percentage of its market potential and
equivalent to the company’s estimated maximum market share for the time period.  In your budget, you’ll want to
forecast the revenues earned from the product against the market potential, as well as against the product’s costs.
Most used forecasts in operations management

• Scheduling: Staff and inventory scheduling are critical functions to meet

demand. This process involves organizing, selecting, and allocating the
necessary resources to complete the desired outputs over a period of time.

• In a service business, for example, a forecast could be used to ensure you

have enough front office employees to meet fluctuating demand that often
involves attending to immediate customer service requests.
Materials requirements planning (MRP)

• This system is used to calculate the

materials needed to manufacture a final
product. MRP requires operations managers
to take inventory, determine if any
additional inventory is needed, and
scheduling production.
 Materials requirements planning (MRP)

•  is a standard supply planning system to help businesses, primarily

product-based manufacturers, understand inventory requirements while
balancing supply and demand. Businesses use MRP systems, which are
subsets of supply chain management systems, to efficiently manage
inventory, schedule production and deliver the right product on time and
at optimal cost.
 How MRP works?

An MRP system accelerates the manufacturing production process by determining

what raw materials, components and subassemblies are needed, and when to
assemble the finished goods, based on demand and bill of materials (BOM). It does
this by asking three main questions:
• What is needed?
• How much is needed?
• When is it needed by?
The answers to these questions provide clarity into what materials are needed, how
many and when to fulfill the required demand and help facilitate an efficient and
effective production schedule.
 Why is MRP important?

MRP gives businesses visibility into the inventory requirements needed to meet demand, helping your business optimize inventory levels
and production schedules. Without this insight, companies have limited visibility and responsiveness, which can lead to:

• Ordering too much inventory, which increases carrying costs and ties up more cash in inventory overhead that could be used
elsewhere.

• Inability to meet demand because of insufficient raw materials, resulting in lost sales, cancelled contracts and out-of-stocks.

• Disruptions in the production cycle, delaying sub-assembly builds that result in increased production costs and decreased output.

Manufacturing companies rely heavily on MRP as the supply planning system to plan and control inventory, scheduling and production,
but MRP is also relevant in many other industries, from retail to restaurants, to create balance between supply and demand.
 MRP Steps and Processes

The MRP process can be broken down into four major steps:

1. Identifying requirements to meet demand

The first step of the MRP process is identifying customer demand and the
requirements needed to meet it, which starts with inputting customer orders and
sales forecasts.

Using the bill of materials required for production, MRP then disassembles demand
into the individual components and raw materials needed to complete the build
while accounting for any required sub-assemblies.
 MRP Steps and Processes

2. Checking inventory and allocating resources

Utilizing the MRP to check demand against inventory and allocating resources
accordingly, you can see both what items you have in stock and where they are—
this is especially important if you have inventory across several locations. This also
lets you see the status of items, which gives visibility into items that are already
allocated to another build, as well as items not yet physically in the warehouse that
are in transit, or on order. The MRP then moves inventory into the proper locations
and prompts reorder recommendations.
 MRP Steps and Processes

3. Scheduling production
Using the master production schedule, the system determines how
much time and labor are required to complete each step of each build
and when they need to happen so that the production can occur
without delay.
The production schedule also identifies what machinery and workstations
are needed for each step and generates the appropriate work orders,
purchase orders and transfer orders. If the build requires subassemblies,
the system takes into account how much time each subassembly takes and
schedules them accordingly.
 MRP Steps and Processes

4. Identifying issues and making recommendations

Finally, because the MRP links raw materials to work orders and
customer orders, it can automatically alert your team when items are
delayed and make recommendations for existing orders: automatically
moving production in or out, performing what-if analyses, and
generating exception plans to complete the required builds.
 MRP Inputs

How well your MRP system works depends on the quality of the data you provide it. For an MRP
system to work efficiently, each input must be accurate and updated. Here are some of the inputs
an MRP depends on:

• Demand – Including sales forecasts and customer orders. When working with predicted
demand, a system that is integrated with an enterprise-wide ERP system allows forecasting
using historical sales vs. just sales forecasts.

• Bill of materials (BOM) – Keeping a single updated version of the bill of materials is essential
for accurate supply forecasting and planning. A system that’s integrated into the enterprise-wide
inventory management system avoids version control issues and building against outdated bills,
which results in reworks and increased waste.
 MRP Steps and Processes

• Inventory – It’s essential to have a real-time view of inventory across the

organization to understand what items you have on hand and which are en route or
have purchase orders issued, where that inventory is and what the inventory’s
status is.

• Master production schedule – The master production schedule takes all build
requirements and plans machinery usage, labor and workstations to account for all
outstanding work orders to be completed.
 MRP Outputs
• Using the provided inputs, the MRP calculates what materials are needed, how much is needed to
complete the build and when in the build process they are needed.

• With this information defined, businesses are able to execute on just-in-time (JIT) production, scheduling
production based on material availability. This minimizes inventory levels and carrying costs, as
inventory is not stored in the warehouse for future production but arrives as needed. By scheduling
materials to arrive and production to begin soon after, businesses can move materials through the
workflow process without delay.

• The MRP lays out the plan of when materials should arrive, based on when they’re needed in the
production process, and when subassemblies should be scheduled. Using a master production plan and
taking into account subassembly build times minimizes materials sitting on shelves and bottlenecks in
the build process.
 MRP Challenges

• Although using an MRP solution is a far better than using spreadsheets for
supply planning, it’s only as good as the data you put into it. The better a
business understands and documents its processes, the better an MRP system
can serve them.

• You need to make sure you input correct inventory availability, time to

complete a subassembly, waste calculations and the lead-times from vendors.
Otherwise, your production schedule will be inaccurate—an MRP can’t
define the production build timeline and materials required if the data isn’t
accounted for in the inventory record, bill of materials and master
production schedule
 MRP Steps and Processes

4. Identifying issues and making recommendations

Finally, because the MRP links raw materials to work orders and
customer orders, it can automatically alert your team when items are
delayed and make recommendations for existing orders: automatically
moving production in or out, performing what-if analyses, and
generating exception plans to complete the required builds.
 MRP vs. ERP

MRP systems focus specifically on planning and controlling how goods are assembled using multiple
raw materials or components by controlling inventory, componentry and the manufacturing process.

Enterprise resource planning (ERP) systems are an offshoot of MRP systems, spurred by businesses
finding a need for the same level of planning and oversight for other operations such as payroll,
finances and supplier management. ERP systems plan for resources across the entire organization,
including: financial management, order management, customer relationship management, people,
procurement, warehousing and fulfillment.