PCOA 001- COMPENSATION MANAGEMENT

MODULE 2 - FORECASTING

Introduction

In this module, we will examine the different types of forecasts and present various
forecasting models. Our purpose is to show that there are many ways for managers to forecast.
This module will also provide an overview of business sales forecasting and describe how to
prepare, monitor, and evaluate the accuracy of a forecast. Good forecasts are an essential part of
efficient service and manufacturing operations.

This module must be completed before you claim your next set of modules of October 29-
30, 2020.

Intended Learning Outcomes:

At the end of the lesson, you can:

1. define forecasting;
2. describe forecasting time horizons and types of forecasting;
3. apply moving average in forecasting;
4. explain the strategic importance of forecasting; and
5. compute for the future demand of organizations using the different approaches to
forecasting

Topic Outline

1. Forecasting
2. Forecasting Time Horizon
3. Types of Forecasts
4. Strategic importance of Forecasting
5. Steps in the Forecasting System
6. Approaches to Forecasting
7. Forecasting in the Service Sector

Course Outline

1. Meaning of Forecasting
2. The Strategic Importance of Forecasting
3. Steps in the Forecasting System
4. Forecasting Approaches

Content

Preliminary Activity
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understanding why in Operations Management forecasting is very essential topic prior to

product creation.
Forecasting Provides a Competitive Advantage for Disney
When it comes to the world’s most respected global brands, Walt Disney Parks and Resorts is a
visible leader. Although the monarch of the magic kingdom is no man but mouse- Mickey
Mouse- its CEO Robert Iger who daily manages the entertainment giant.
Disney’s global portfolio includes Hong Kong Disneyland (opened 2005), Disneyland Paris
(1992), and Tokyo Disneyland (1983). But it is Walt Disney World Resort (in Florida) and
Disneyland Resort (in California) that drive profits in this $40 billion corporation, which is
ranked in the top 100 in both the Fortune 500 and Financial Times Global 500.
Revenues at Disney are all about people- how many visit the parks and how they spend money
while there. When Iger receives a daily report from his four theme parks and two water parks
near Orlando, the report contains only two numbers: the forecast of yesterday’s attendance at
the parks (Magic Kingdom, Epcot, Disney’s Animal Kingdom, Disney’s Animal Kingdom,
Disney-Hollywood Studios, Typhoon Lagoon, and Blizzard Beach) and the actual attendance. An
error close to zero is expected Iger takes his forecasts very seriously.
The forecasting team at Walt Disney World Resort doesn’t just do a daily prediction, however,
and Iger is not its only customer. The team also provides daily, weekly, monthly, annual, and 5-
year forecasts to the labor management, maintenance, operations, finance, and park scheduling
departments. Forecasters are judgmental models, econometric models, moving-average models,
and regression analysis.
With 20% of Walt Disney World Resort’s customers coming from outside the United States, its
economic model includes such variables as gross domestic product (GDP), cross-exchange rates,
and arrivals into the U.S. Disney also uses 35 analysts and 70 field people to survey 1 million
people each year. The survey’s administered to guests at the parks and its 20 hotels, to
employees, and to travel industry professionals, examine future travel plans and experiences at
the parks. This helps forecast not only attendance but behaviour at each ride (e.g. how long
people will wait, how many times they will ride). Inputs to the monthly forecasting model
include airline specials, speeches by the chair of the Federal Reserve, and Wall Street trends.
Disney even monitors 3,000 school district inside and outside the U.S. for holiday/vacation
schedules. With this approach, Disney’s 5-year attendance forecast yields just a 5% error on
average.
Attendance forecasts for the parks drive a whole slew of management decision. For example,
capacity on any day can be increased by opening at 8 a.m., instead of the usual 9 a.m., by
opening more shows or rides, by adding more food/beverage carts (9 million hamburgers and 50
million Cokes are sold per year), and Cast members are scheduled in 15-minute intervals
throughout the parks for flexibility. Demand can be managed by limiting the number of guests
admitted to the parks, with the “FAST PASS” reservation system, and by shifting crowds from
rides to more street parades.
At Disney, forecasting is a key driver in the company’s success and competitive advantage!
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FORECASTING

One crucial activity that operations managers perform before creating a product is
forecasting. This is an activity of anticipating future events to prepare the organization for future
production activity, human resource planning, and supply chain management.

Managers, on the other hand, make decisions without knowing what will happen in the
future. They order inventory without knowing their sales would be. Managers simply make their
best estimates of what will happen in the future in the face of uncertainty.

Forecasting is both the science and art of predicting future events. This may involve
taking historical data (such as previous sales or demand) and projecting them into the future
with a mathematical model. This may also be a subjective projection or an intuitive prediction.

Forecasting Time Horizon

A forecast can be divided by future time horizons, which may fall into three categories:

1. Short-range forecast. This forecast has a period of up to one year. It is used for planning
purchasing, job scheduling, workforce levels, job assignments, and production levels.
2. Medium-range forecast. A medium-range or intermediate forecasting that generally
spans from three months to three years. This is used for forecasting sales planning,
production planning and budgeting, cash budgeting, and analysis of various operating
plans.
3. Long-range forecast. This type of projection spans up to 3 years and hence and is used for
forecasting new products, capital expenditures, facility location or expansion, and
research and development.

Types of Forecast

Organizations may use either of the following forecasting types in planning future
operations:

1. Economic forecast. Planning indicators that are valuable in helping organizations prepare
medium to long-range forecasts. This addresses the business cycle by predicting inflation
rates, money supplies, and other planning indicators.
2. Technological forecast. This is concerned with the rates of technological progress,
resulting in the birth of new industries.
3. Demand forecast. This include projection of demand or the company’s products and
services

STRATEGIC IMPORTANCE OF FORECASTING

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Forecasting plays an essential role in the creation of products for an organization. The
forecast is the only estimate of demand until actual demand becomes known, and therefore
drives decisions in many areas.
Let us look at the impact of product demand forecast on three activities: (1) supply-chain
management, (2) human resources, and (3) capacity.
1. Supply-Chain Management. Good supplier relations and assurance of continuous
product innovation and cost-plus speed of delivery are mostly dependent on the forecast.
2. Human Resources. Hiring, training, and laying off workers all depend on anticipated
demand. If the organization hires without projecting the demand, the cost of hiring and
maintaining employees is high, and the organization suffers.
3. Capacity. When the ability of the organization becomes inadequate due to poor forecast,
then it may result in shortages that will put the organization at to disadvantage.

Activity 1

Instructions: Answer the following questions. Use a separate sheet of paper, and do not
forget to write your complete name.

1. Define forecasting and give reasons why organizations need to forecast.

2. Give distinct characteristics of each of the time horizons of forecasts.

SEVEN STEPS IN THE FORECASTING SYSTEM

In forecasting the sales or demand of the organization, operations managers usually

follow the seven necessary steps:

1. Determine the use of the forecast. Example: Decisions on hiring Staff, opening times, etc.
2. Select the items to be forecast. Example: labor, maintenance, and scheduling.
3. Determine the time horizon of the forecast. Example: Determining whether it is a short,
medium, or long-range forecast.
4. Select the forecasting model. Will the company use a statistical model like moving
averages, exponential smoothing, or linear regression?
5. Gather the data needed to make a forecast. for Example; Previous year’s sales or previous
demand for products and services.
6. Make the forecast.
7. Validate and implement the result. Forecasts are reviewed at the highest levels to ensure
that the model, assumptions, and data are valid.

FORECASTING APPROACHES

There are two basic approaches used in making a forecast:

1. The module is for the exclusive use of the University of La Salette, Inc. Any form of reproduction, distribution, uploading, or
Quantitative forecast. Forecasting employs mathematical models that rely on
posting online in any form or by any means without the written permission of the University is strictly prohibited.
historical data and or associative variables to forecast sales or demand.

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2. Qualitative forecast. Forecast incorporates such factors as the decision maker’s

intuition, emotions, personal experiences, and value system.

Overview of the Qualitative Methods

In this section, we consider four different qualitative techniques:

1. The jury of Executive Opinion. A forecasting technique that uses the opinions of a
small group of high-level managers to form a group estimate of demand.
2. Delphi Method. There are three different types of participants in the Delphi method:
decision-makers, staff personnel, and respondents. Decision-makers consist of a group of
5 to 10 experts who will be making the actual forecasts. Staff personnel assists decision-
makers by preparing, distributing, collecting, and summarizing a series of questionnaires
and survey results. The respondents are a group of people, often located in different
places, whose judgments are valued. This group provides inputs to the decision-makers
before the forecast is made.
3. SalesForce Composite. A forecasting technique based on salespersons’ estimates of
expected sales or demand.
4. Market Survey. A forecasting method that solicits input from customers or potential
customers regarding plans.

Overview of Quantitative Methods

There are five quantitative methods under this approach of forecasting:

1. Naïve approach
2. Moving averages
3. Exponential smoothing
4. Trend projection
Note: these quantitative approaches are all time-series models. Time series models predict
future events on the basic assumption that the future is a function of the past

5. Linear regression

Note: Linear regression is an associative model. The associative model incorporates the
various factors that might influence the quantity being forecast. Example: Advertising,
competitor’s prices, and the like.

Decomposition of a Time Series

Analyzing time series means breaking down past data into components and then
projecting them forward. It has four features:
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1. Trend. It is the gradual upward or downward movement of data over time.

2. Seasonality. It is a data pattern that repeats itself after days, weeks, months, or quarters.
Example:
PERIOD LENGTH “SEASON” LENGTH NUMBER OF “SEASONS”
IN PATTERN
Week Day 7
Month Week 4-4 1/2
Month Day 28-31
Year Quarter 4

3. Cycles. They are patterns in the data that occur every several years. They are usually tied
into the business cycle and are important in short-term business analysis and planning.
Predicting business cycles is difficult because they may be affected by political events or by
international turmoil.

4. Random Variations. Are “blips” in the data caused by chance and unusual
situations. They follow no discernible pattern, so they cannot be predicted.

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Year

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Overview of the Qualitative Approaches

1. Naïve Approach

As the term suggests, the Naïve approach is the simplest model in forecasting for the
demand for the next period will be equal to the demand in the most recent period.

2. Moving Averages

Moving averages is a forecasting method that uses an average of the n most recent periods of
data to forecast the next period. It follows the formula:

Moving Average = ∑ demand in previous n periods

n

Note: n is the number of periods in the moving average.

Moving averages have two types:

1. The moving Average

2. The weighted Moving Average
For Moving Average:

Example: Donna’s Garden Supply wants a 3-month moving average forecast, including a
forecast for next January, for shed sales.
Storage shed sales are shown in the middle column of the table below. A 3-month moving
average appears on the right.

Month Actual Shed Sales 3-Month Moving Average

January 10
February 12
March 13
April 16 10 + 12 + 13/3 = 11.67*
May 19 12 +13 + 16/3 = 13.67
June 23 13 +16 + 19/3 = 16
July 26 16 +19 +23/ 3 = 19.33
August 30 19 + 23 + 26/3 = 22.67
September 28 23 + 26 + 30/3 = 26.33
October 18 26 + 30 + 28/ 3 = 28
November 16 30 + 28 + 18/3 = 25.33
December 14 28 + 18 + 16/3 = 20.67
Note: 11.67* is obtained by getting the average of actual Shed sales or 10 (sales from January), 12
(sales from February) and 13 (sales from March).

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For Weighted Moving Average:

Example: Donna’s Garden Supply (from the first example) wants to forecast storage shed
sales by weighting the past three months with more weight given to recent data to make them
more significant.
The approach is to assign more weight to recent data as follows:

Weights Applied Period

3 Last month
2 Two months ago
1 Three months ago
_____
6 Sum of weights

Forecast for this month = 3 X Sales last mo. + 2 x Sales 2 mos. ago + 1 x Sales 3mos. ago
Sum of the weights

MONTH ACTUAL SHED SALES 3-MONTH WEIGHTED

MOVING AVERAGE
January 10
February 12
March 13
April 16 {(3x13)+(2x12)+(1x10)}/6=
12.17
May 19 {(3x16)+(2x13)+(1x12)}/6=
14.33
June 23 {(3x19)+(2x16)+(1x13)}/6 = 17
July 26 {(3x23)+2x19)+(16)}/6 = 20.5
August 30 {(3x26)+(2x23)+(19)}/6 =23.83
September 28 {(3x30)+(2x26)+(23)}/6 =27.5
October 18 {(3x28)+(2x30)+(26)}/6 =
28.33
November 16 {(3x18)+(2x18)+(30)}/6 = 23.33
December 14 {(3x16)+(2x18)+(28)}/6 = 18.67

Activity 2

Instructions: Write your answer on a separate sheet of paper, and do not forget to
write your complete name on it.

Sales of hairdryers at the Walgreen stores in Youngstown, Ohio, over the past 4 months
have been 200, 210, 220, and 330 units (with 330 being the most recent sales)

Required: Develop a moving-average forecast for the next month, using these three
techniques:
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a. 3-month moving average

b. 4-month moving average
c. weighted 4-month moving average with the most recent month weighted 4, the
preceding month 3, then 2, and the oldest month weighted 1.
d. if next month’s sales turn out to be 280 units, forecast the following month’s sales
using a 4-month moving average.

3. Exponential Smoothing

For our lesson on exponential smoothing, watch this link:

https://www.youtube.com/watch?v=k_HN0wOKDd0

4. Trend Projection and Seasonal Indices:

For our lesson on Trend Projection and Seasonal Indices, watch this link:

https://www.youtube.com/watch?v=rnihVLCPDzc

Activity 3

Instructions: Write your answer on a separate sheet of paper, and do not forget to
write your complete name on it.

The demand for heart transplant surgery at the Philippine General Hospital in Metro
Manila has increased steadily in the past few years:

YEAR 1 2 3 4 5 6
HEART TRANSPLANT 49 50 52 56 58 ?

The director of medical services predicted six years ago that demand in year 1
would be 41 surgeries.

Required:

1. Use exponential smoothing, first with a smoothing constant of .6 and then with
one of .9, to develop forecasts for years 2 through 6.

2. What effect does the value of the smoothing constant have on the weight given to
the current value?

Associative
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5. Linear Regression. Linear regression usually considers various variables that are
related to the quantity being forecasted. Once these variables have been found, a statistical
model is built and used to predict the item of interest. In other words, we follow the formula for
trend projection; however, the value of X this time as a dependent variable (the time) becomes
the independent variable. As such, it includes advertising, competitor’s prices, and company’s
prices, etc.

Formula: ŷ = a + bx

Where: ŷ =value of the dependent variable

a = y-axis intercept
b = slope of the regression line
x = independent variable

Example: Computing a Linear Regression

Nodel Construction Company renovates old homes in West Bloomfield, Michigan. Over
time, the company has found that its dollar volume of renovation work is dependent on the West
Bloomfield area payroll. Management wants to establish a mathematical relationship to help
predict sales.

Nodel’s VP of operations has prepared the following table, which lists company revenues
and the amount of money earned by wage earners in West Bloomfield during the past 6 years:
Nodel’s SALES (in $ Millions), AREA PAYROLL (in Billions), x
y
2.0 1
3.0 3
2.5 4
2.0 2
2.0 1
3.5 7

Solution: We can find a mathematical equation by using the regression approach:

SALES, y PAYROLL, x x² xy
2.0 1 1 2.0
3.0 3 9 9
2.5 4 16 10
2.0 2 4 4
2.0 1 1 2
3.5 7 49 24.5
∑y= 15 ∑x= 18 ∑x²=80 ∑xy= 51.5

X= Ʃx = 18 = 3
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y = Ʃy = 15 = 2.5
6 6

b= Ʃxy – nxy = 51.5 – (6) (3) (2.5) = .25

Ʃx^2 – nx ^2 80-(6)(3^2)

a= y - bx = 2.5 – (.25) (3) = 1.75

The estimated regression equation, therefore, is:

ȳ = 1.75 +.25x
Sales = 1.75 + .25 (payroll)

If the local chamber of commerce predicts that the West Bloomfield area payroll will be $6
billion next year, we can estimate sales for Nodel with the regression equation:

Sales (in $ millions) = 1.75 + .25 (6)

= 1.75 + 1.50 = 3.25

or Sales =$ 3,250.000

Activity 4

Instructions: Write your answer on a separate sheet of paper and do not forget to write
your complete name on it.

Mark Greshon, the owner of a musical instrument distributorship, thinks that demand for
guitars may be related to the number of television appearances by the popular group Maroon
5 during the previous month. Mark has collected the data shown in the following table:

Demand for Guitars 3 6 7 5 10 7

Maroon 5 TV Appearances 3 4 5 4 7 5

Required:
Use the linear regression method to derive a forecasting equation. What are your estimated
guitar sales if Maroon 5 performed on TV nine times last month?

Forecasting in the Service Sector

Forecasting in the service sector presents some unusual challenges. A powerful technique
in the retail sector is tracking demand by maintaining good short-term records. For instance, a
barbershop
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Saturday. A downtown restaurant, on the other hand, may need to tract conventions and
holidays for effective short-term forecasting.

Specialty Retail Shops

Specialty retail facilities, such as flower shops, may have other unusual demand patterns,
and those patterns differ depending on the holiday. When Valentine’s Day falls on a weekend,
flowers can’t be delivered to offices, and those romantically inclined are likely to celebrate with
outings rather than flowers. If a holiday falls on a Monday, some celebrations may also occur on
the weekend, reducing flower sales. However, when Valentine’s falls in midweek, busy midweek
schedules often make flowers the optimal way to celebrate.

Due to unique demand patterns, many service firms maintain records of sales, noting not
only the day of the week but also unusual events, including the weather, so that practices that
influence demand can be developed.

Fast-Food Restaurants

Fast-food restaurants are well aware not only of weekly, daily, and hourly but even 15-
minute variations in demands that influence sales; therefore, detailed forecast of demand are
needed. They also take note of the lunchtime and dinnertime peaks.

Activity 5

Instructions: Write your answer in a separate sheet; do not forget to write your name.

Synthesize exponential smoothing and trend projection as presented in the videolink given
below and justify which quantitative methods could provide an accurate measure of forecast.

https://www.youtube.com/watch?v=k_HN0wOKDd0

https://www.youtube.com/watch?v=rnihVLCPDzc

Summary

Forecasts are a critical part of the operations manager’s function. Demand forecasts drive
a firm’s production, capacity, and scheduling systems and affect the financial, marketing, and
personnel planning functions.

There is a variety of qualitative and quantitative forecasting techniques. Qualitative

approaches employ judgment, experience, intuition, and a host of other factors that are difficult
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to quantify. Quantitative forecasting uses historical data and causal or associative relations to
project future demands.

No forecasting method is perfect under all conditions. And even once management has
found the right approach, it must still monitor and control forecasts to make sure errors do not
get out of hand. Forecasting can often be a very challenging but rewarding part of managing.

References

Chapman, S. N. (2006). Fundamentals of production planning management. England. Mc

Graw Hill
Heizer, J., & Render, B. (2014). Operations management: Sustainability and supply chain
management. 11th edition. The United States of America. Pearson Education Limited.

Supplementary Readings

Berenson, M., Tim, K., & Levine, D. (2012). Basic Business Statistics, 12th edition. NJ Prentice
Hall.

Wilson, J. H., Keating, B. & Galt, J. (2012). Business forecasting. 7th edition. New York.
McGraw- Hill

Emmanuel, J. (2015). Forecasting: Exponential Smoothing, MSE,

https://www.youtube.com/watch?v=k_HN0wOKDd0

Bahaw, P. (2017). Trend projection & linear regression lecture 2

https://www.youtube.com/watch?v=rnihVLCPDzc

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