POM

Module 3: Demand Forecasting

Unit 2: Types of Forecasting Methods

Overview:

“To handle the increasing variety and complexity of managerial forecasting problems,
many forecasting techniques have been developed in recent years. Each has its special
use, and care must be taken to select the correct technique for a particular application.
The manager as well as the forecaster has a role to play in technique selection; and the
better they understand the range of forecasting possibilities, the more likely it is that a
company’s forecasting efforts will bear fruit.

“The selection of a method depends on many factors—the context of the forecast, the
relevance and availability of historical data, the degree of accuracy desirable, the time
period to be forecast, the cost/ benefit (or value) of the forecast to the company, and the
time available for making the analysis.

“These factors must be weighed constantly, and on a variety of levels. In general, for
example, the forecaster should choose a technique that makes the best use of available
data. If the forecaster can readily apply one technique of acceptable accuracy, he or she
should not try to “gold plate” by using a more advanced technique that offers potentially
greater accuracy but that requires nonexistent information or information that is costly to
obtain. This kind of trade-off is relatively easy to make, but others, as we shall see, require
considerably more thought.

“Furthermore, where a company wishes to forecast with reference to a particular product,

it must consider the stage of the product’s life cycle for which it is making the forecast.
The availability of data and the possibility of establishing relationships between the factors
depend directly on the maturity of a product, and hence the life-cycle stage is a prime
determinant of the forecasting method to be used.”
https://hbr.org/1971/07/how-to-choose-the-right-forecasting-technique

Module Objective:
After successful completion of this Unit, you should be able to:

• Identify the basic types of forecasting methods

• Describe the most commonly used qualitative forecasting methods
• Describe the time series and causal quantitative forecasting techniques
Course Materials:
• Handout: Forecasting Methods

Read:
FORECASTING METHODS

The two basic forecasting methods described in this chapter are the qualitative and
quantitative methods. Qualitative or judgmental forecasting methods, which are more
suitable for long-range forecasts, predominantly utilize personal opinion, experience,
and relevant information. Quantitative forecasting techniques, which are more
appropriate for medium and short- range forecasts, predominantly use mathematical
models or formulas to develop forecasts based on past numerical demand data.

Qualitative forecasting should be used for new product

introduction, where historical data is not available, or if they
are, may show a demand pattern not suitable for
mathematical modeling. In this case, the selective use of
market research data or a method called historical analogy is
used to come up with a demand forecast. Other qualitative
forecasting methods include market or consumer surveys,
sales force composite, executive opinion, and the Delphi
technique.
In historical analogy, also known as life-cycles analogy,
prediction of a product’s demand is based on the introduction,
growth, maturity, and decline phases of existing similar
products.

In market or consumer surveys, questionnaires or telephone

surveys, panels, or test markets may be used to gather data
from existing and potential customers regarding their present
buying behavior and future purchasing plans.

In sales force composite, each sales representative estimates

the sales in his or her jurisdiction. The estimates are reviewed
and combined at succeeding higher levels of the management
hierarchy.
 In executive opinion, the executives of the organization, such as the
marketing, production operations and finance managers, discuss until
they arrive at a consensus forecast.

In the Delphi technique, no discussion is done among

the members of a panel of experts and yet they have
to arrive at a consensus forecast. A facilitator
prepares, distributes, collects, and summarizes a
series of questionnaires and survey results. The
panel of experts answers the questions on
successive rounds, their responses treated
anonymously. On each round, responses are fed
back to all panel members, giving each of them a
chance to modify his or her forecast. The forecasting
process stops when the facilitator is convinced that
the forecasts have converged within an acceptable
range.
Quantitative forecasting approaches can be
further subdivided into two types – the time
series models and the causal or explanatory or
associative models. A time series is a sequence
or chain of historical data gathered and
recorded at regular time intervals. For example,
a product’s actual demand or sales data
recorded on a weekly basis is a time series. In
time series models, a mathematical model that
closely fits the demand pattern – the past
relationship between demand and time – is
determined. Forecasts are obtained by
projecting the demand pattern into the future.
In this course, we will consider these time
series forecasting models: the naïve approach,
simple moving average, weighted moving
average, and exponential smoothing.

In using causal models, the forecaster looks for

an independent variable or variables (x),
Y = a + bX including time, which may consistently
influence demand (y). A mathematical model
that describes the relationship between the
independent variable(s) and demand is then
𝐒𝐒𝐒𝐒𝐒𝐒𝐒𝐒𝐒𝐒 = 𝒃𝒃 =
𝚫𝚫𝚫𝚫
𝚫𝚫𝚫𝚫 derived. The resulting model is used to forecast
demand using given values of the independent
variable(s). Both time series and causal
𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈 = 𝒂𝒂 forecasting assume that the past relationship
between demand and the independent
variable(s) will continue on into the future.
 Review:

Activities/Assessments:
Activity __.