Purchasing and Forecasting

Techniques
Prof P.P.Sengupta
Need for Forecasting in Purchasing
• In the business world, uncertainty is a constant. Forecasts provide a sense of
direction and help businesses make proactive decisions rather than reacting
to sudden changes.
• Forecasts help organizations plan production, allocate resources, and manage
inventory effectively.
• This is particularly crucial for purchasing decisions, as it ensures the right
amount of products is available at the right time, preventing both
overstocking and stockouts.
• Real-Life Example: An electronics manufacturer needs to decide how many
units of a new smartphone to produce. Forecasting helps them avoid excess
production, which can lead to storage costs, or falling short of demand.
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Importance of Forecasting
• Importance: Accurate forecasting leads to improved customer
satisfaction, reduced costs, and optimized resource allocation.
• Businesses can avoid overinvesting in inventory or production by
accurately forecasting customer demand. For example, a fashion
retailer can stock up on popular clothing styles and avoid excess
inventory of less popular items.
• Real-Life Example: A beverage company uses forecasting to anticipate
summer demand for their popular soft drinks, ensuring they have
enough supply to meet the peak demand and avoid stockouts.

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Steps for Forecasting

• Define the objective: Clearly state what you want to achieve through forecasting.
• Gather historical data: Collect relevant data to analyze past trends and patterns.
• Choose a suitable method: Select an appropriate forecasting technique based on the nature of data
and objectives.
• Apply the chosen method: Utilize the method to generate forecasts for future periods.
• Monitor and adjust: Continuously compare actual data with forecasts and adjust methods as needed.
• These steps ensure a systematic approach to forecasting. By defining clear objectives and gathering
relevant data, businesses can choose the right forecasting method. Regularly monitoring and adjusting
forecasts based on actual data ensures ongoing accuracy.
• Real-Life Example: A technology company defines its objective as forecasting quarterly sales for a new
software product. They gather sales data from the past two years, use time series analysis to forecast
future sales, and regularly compare their forecasts with actual sales data to refine their methods.

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Attributes of Good Forecasting Techniques

• Accuracy and Reliability: Forecasts should be close to actual outcomes consistently.

• Consistency: The chosen method should yield consistent results over time.
• Flexibility: Techniques should adapt to changing market conditions.
• Simplicity: Methods should be straightforward and not overly complex.
• Cost-Effectiveness: Techniques should offer value in relation to the resources invested.
• Each attribute contributes to the quality of forecasting. For instance, a consistent method
helps build trust in the accuracy of forecasts, while simplicity ensures that the method
can be easily understood and applied by the team.
• Real-Life Example: An automotive manufacturer aims to forecast demand for various
car models. They opt for a forecasting technique that provides accurate results and
adjusts well to seasonal variations without requiring excessive data or resources.

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Demand Analysis

• Analyzing historical demand patterns helps identify trends,

seasonality, and anomalies.
• Demand analysis involves scrutinizing historical data to understand
patterns in customer behavior. For instance, a hotel may notice that
room bookings increase during the holiday season, allowing them to
plan staffing and inventory accordingly.
• Real-Life Example: A grocery chain analyzes past sales data to
understand that ice cream sales peak during the summer months and
dip significantly in winter, enabling them to plan inventory levels
accordingly.

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Types of Forecasting Methods

• Qualitative Methods: Rely on expert opinions and subjective judgment.

• Quantitative Methods: Use historical data and mathematical models for
predictions.
• Qualitative methods are helpful when data is limited or when a situation
is too complex for quantitative models. For instance, a startup may rely
on expert opinions to forecast demand in a new market.
• Real-Life Example: A fashion retailer uses qualitative methods to predict
upcoming trends by consulting fashion experts and influencers when
deciding which styles to stock next season.

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Qualitative and Quantitative Methods

• Qualitative Methods
• Expert Opinion
• Delphi Method
• Market Research
• Quantitative Methods
• Time Series Analysis
• Causal Methods
• Judgmental Forecasting

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Different Types of Qualitative Methods
• Expert Opinion: Collect insights from industry experts to make informed forecasts.
• Real-Life Example: A pharmaceutical company uses expert opinions from doctors
and researchers to forecast the demand for a new drug.
• Delphi Method: Iterative approach where experts provide anonymous input, and
consensus is reached.
• Real-life Example: A government agency uses the Delphi method to forecast
economic indicators by collecting input from various economists anonymously.
• Market Research: Surveys and focus groups to gather customer preferences and
opinions.
• Real-Life Example: A fast-food chain conducts market research to understand
customer preferences and anticipate demand for new menu items.

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Different Types of Quantitative
Forecasting Methods
• Time Series Analysis: Analyzing historical data to predict future values based on patterns.
• Causal Methods: Relating sales to external factors like economic indicators or advertising
spending.
• Real-Life Example: An automobile manufacturer correlates car sales with consumer sentiment
indices to predict future sales based on economic conditions.
• Judgmental Forecasting: Combining expert opinions with statistical data for more accurate
forecasts.
• Real-Life Example: A retail chain combines expert opinions and historical sales data to predict
demand for a new product line.
• We often use a combination of qualitative and quantitative forecasting methods.
• Real-Life Example: An electronics company combines market research and time series analysis
to forecast smartphone sales. They analyze historical sales data and conduct surveys to
understand customer preferences for features, colors, and sizes.

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Time Series Analysis

• Time series analysis is a statistical technique used to

analyze and forecast patterns and trends within a
sequence of data points ordered over time.
• It focuses on understanding the underlying patterns,
seasonality, and fluctuations in a time-dependent
dataset to make predictions about future values.

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Time Series Analysis
• Real-Life Example: Consider a company's monthly sales data over the
past three years. By applying time series analysis, the company
identifies a consistent increase in sales each year during the holiday
season (seasonality). The model captures this trend and predicts
higher sales during the upcoming holiday season, allowing the
company to adjust inventory and marketing strategies accordingly.
• Time series analysis is a powerful tool in quantitative forecasting,
enabling businesses to make data-driven predictions about future
values based on historical patterns.

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Process of Time Series Analysis
• Data Collection: Gather historical data points over a specific time
period. This data can be collected at regular intervals, such as hourly,
daily, monthly, or yearly, depending on the context.
• Data Exploration: Plot the data points in chronological order to
visualize the trends, patterns, and potential seasonality. This helps
identify any obvious trends or anomalies.
• Decomposition: Decompose the time series data into its components:
trend, seasonality, and random fluctuations (noise). This step helps
separate the systematic patterns from random variations.

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Decomposition
• Components of Time Series Decomposition:
• Trend: The trend component represents the long-term movement or direction
of the data. It indicates whether the data is generally increasing, decreasing,
or remaining stable over time.
• Seasonality: The seasonality component captures repetitive and predictable
patterns that occur at fixed intervals, such as daily, weekly, monthly, or yearly
cycles. It reflects the influence of seasonal factors on the data.
• Residual (Noise): The residual component represents the random fluctuations
or variations that remain after the trend and seasonality components have
been accounted for. These are often attributed to factors that are difficult to
model, such as unpredictable events and measurement errors.

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Example of Decomposition: Retail Sales

• Consider a retail business's monthly sales data for several years. After
decomposing the data, the analysis might reveal:
• A steady increasing trend in sales, indicating business growth.
• A repeating seasonal pattern with higher sales during holiday seasons.
• Random fluctuations around the trend and seasonality components.
• This decomposition provides insights into the business's growth trajectory, its
seasonal peak periods, and the variation that is unrelated to these factors.
• In summary, decomposition is a crucial step in time series analysis that helps
analysts uncover the various components of a time series, enabling more
accurate forecasts and a deeper understanding of the data's behavior over
time.

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Models for Time Series Analysis
1.Common models include:
1. ARIMA (AutoRegressive Integrated Moving Average): Suitable for data with a clear temporal dependence, it
combines autoregressive (AR) and moving average (MA) components.
2. Exponential Smoothing Models: These models give more weight to recent observations, making them suitable
for data with no apparent trend or seasonality.
3. Prophet: A model developed by Facebook for time series forecasting, designed to handle data with various
patterns.
2.Model Fitting: Fit the chosen model to the historical data. This involves estimating the model's
parameters to best capture the observed patterns.
3.Forecasting: Use the fitted model to predict future values of the time series. This can involve
projecting both point forecasts (single values) and prediction intervals (ranges of possible values) to
account for uncertainty.
4.Model Evaluation: Evaluate the model's performance by comparing its forecasts to actual data.
Metrics like Mean Absolute Error (MAE), Root Mean Squared Error (RMSE), and Mean Absolute
Percentage Error (MAPE) are commonly used to assess accuracy.

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Dependent and Independent Variables in
Forecasting
• In forecasting, dependent and independent variables are terms used to describe the
relationship between two or more variables when trying to make predictions or understand
patterns
• Dependent Variable:
• The dependent variable, also known as the "outcome" or "target" variable, is the variable
you're trying to predict or explain. It's the variable that changes in response to the
independent variables. In a forecasting context, the dependent variable is what you're
interested in forecasting.
• Independent Variable:
• Independent variables, also known as "predictors" or "features," are variables that are
believed to influence or have a relationship with the dependent variable. They are used to
explain or predict changes in the dependent variable. In forecasting, these are the variables
you use to make predictions about the future values of the dependent variable.

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Examples of Dependent and Independent Variables: Sales Forecasting for Air
Conditioners

• Dependent Variable: Sales Revenue. This is what you're trying to predict. The sales revenue is
influenced by various factors, and you want to understand how these factors affect the revenue.
• Independent Variables: Advertising Spend (in Rs), Number of Promotional Events, Average
Temperature (in degrees Fahrenheit)
• These are the variables you believe are related to sales revenue. You suspect that higher
advertising spending, more promotional events, and certain temperature ranges might lead to
increased sales.
• In this example, sales revenue is the dependent variable, while advertising spend, number of
promotional events, and average temperature are the independent variables. By analyzing the
relationship between the dependent and independent variables, you can build a forecasting
model that helps predict sales revenue based on these factors.
• In summary, the dependent variable is what you're trying to predict or explain, and the
independent variables are the factors you use to make those predictions or explanations in
forecasting scenarios.

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More Examples
• Example: Electricity Demand Forecasting
• Dependent Variable: Electricity Consumption (in megawatt-hours)
• Independent Variables:
• Time of Day (morning, afternoon, evening)
• Temperature (in degrees Celsius)
• Day of the Week (Monday to Sunday)
• Example: Real Estate Price Prediction
• Dependent Variable: House Price
• Independent Variables:
• Square Footage of the Property
• Number of Bedrooms
• Proximity to Public Transportation

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Regression Analysis for Forecasting

• Regression analysis helps identify relationships between a dependent variable (the one
you want to predict) and one or more independent variables (predictors). In forecasting,
regression can be used to model the relationship between historical data and predict
future values.
• Linear Regression: This technique models the relationship between the dependent
variable and one or more independent variables by fitting a linear equation. The equation
can then be used to predict future values of the dependent variable.
• Application: In retail, linear regression can be used to forecast future sales based on
factors like advertising spending, economic indicators, and historical sales data. For
instance, a company can predict how changes in their advertising budget will impact
future sales volume.
• Application: In the energy sector, time series regression can be used to forecast electricity
demand based on historical consumption patterns, weather data, and economic variables.

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Correlation Analysis for Forecasting:

•Correlation measures the strength and direction of the relationship between two
variables. While correlation does not imply causation, understanding correlations between
variables can provide insights for forecasting.
•Positive Correlation: If two variables have a positive correlation, as one variable increases,
the other tends to increase as well.
•Application: In the tourism industry, there might be a positive correlation between hotel
occupancy rates and local events. Forecasting an upcoming event's impact on hotel
bookings becomes more accurate when this correlation is considered.
•Negative Correlation: If two variables have a negative correlation, as one variable
increases, the other tends to decrease.
•Application: In financial markets, there could be a negative correlation between the value
of the U.S. dollar and the price of commodities like gold. Understanding this correlation
can help predict changes in commodity prices based on currency movements.

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Forecasting for Different Goods

• Different goods require tailored forecasting methods due to their

unique characteristics.
• Explanation: Different Types of Goods have distinct demand patterns
based on their attributes. For instance, forecasting demand for
perishable goods like fresh produce involves considering spoilage
rates and seasonality, while forecasting for durable goods might rely
more on time series analysis.
• Forecasting methods for Capital goods, consumables, and spare parts
are different.

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Selecting a Suitable Method

• Factors: Consider data availability, resources, and the nature of the

product/service.
• The choice of forecasting methods should align with the business's
specific context. For example, a small startup with limited historical
data may choose qualitative methods, while a well-established
retailer with abundant data may opt for quantitative methods.
• Real-Life Example: A bakery uses a combination of time series analysis
and judgmental forecasting to predict demand for various types of
bread. They find that using both methods provides more accurate
forecasts during seasonal changes.

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Challenges in Forecasting

• Challenges are issues like demand variability, market uncertainties,

and incomplete data.
• Explanation: Businesses face various challenges in forecasting due to
the dynamic nature of markets. For instance, the fashion industry
deals with constantly changing trends, making accurate forecasts very
challenging.
• Real-Life Example: An outdoor equipment retailer faces challenges in
forecasting due to weather-dependent demand for camping gear.
Unpredictable weather patterns can lead to inaccurate forecasts.

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Benefits of Effective Forecasting

• Improved inventory management, cost reduction, and enhanced

customer satisfaction.
• Real-Life Example: An online retailer that accurately forecasts demand
for holiday sales avoids overstocking, reduces storage costs, and
prevents stockouts, leading to satisfied customers.

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