LESSON 4

FORECASTING

TOPICS: LEARNING OUTCOMES:

 Definition of Forecasting At the end of the lesson,
 Seven Steps in the Forecasting students must be able to:
System 1. Understand the significance of
 Forecasting Time Horizons forecasting in business
 Forecasting Approaches organizations especially in
 Qualitative Forecasting Operations Management,
Methods 2. Compute and apply different
 Quantitative Forecasting approaches and methods in
Methods forecasting demand.

Topic 1: Definition of Forecasting

Every day, managers like those at Disney make decisions without knowing what
will happen in the future. They order inventory without knowing what sales will be,
purchase new equipment despite uncertainty about demand for products, and make
investments without knowing what profits will be. Managers are always trying to make
better estimates of what will happen in the future in the face of uncertainty. Making
good estimates is the main purpose of forecasting (Heizer, et.al. 2017). It should be kept
in mind that, in business, forecasting can only be done with basis or foundation.
Forecasting is the art and science of predicting future events. Forecasting may
involve taking historical data (such as past sales) and projecting them into the future
with a mathematical model. It may be a subjective or an intuitive prediction (e.g., “this
is a great new product and will sell 20% more than the old one”). It may be based on
demand-driven data, such as customer plans to purchase, and projecting them into the
future. Or the forecast may involve a combination of these, that is, a mathematical
model adjusted by a manager’s good judgment (Heizer, et.al. 2017).
Organizations use three major types of forecasts in planning future operations
(Heizer, et.al. 2017):

1. Economic forecasts address the business cycle by predicting inflation rates,

money supplies, housing starts, and other planning indicators.
2. Technological forecasts are concerned with rates of technological progress,
which can result in the birth of exciting new products, requiring new plants and
equipment.
3. Demand forecasts are projections of demand for a company’s products or
services. Forecasts drive decisions, so managers need immediate and accurate
information about real demand. They need demand-driven forecasts, where the
focus is on rapidly identifying and tracking customer desires. These forecasts
may use recent point-of-sale (POS) data, retailer-generated reports of customer
preferences, and any other information that will help to forecast with the most
current data possible. Demand-driven forecasts drive a company’s production,
capacity, and scheduling systems and serve as inputs to financial, marketing, and

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 personnel planning. In addition, the payoff in reduced inventory and
obsolescence can be huge.

Economic and technological forecasting are specialized techniques that may fall
outside the role of the operations manager (Heizer, et.al. 2017). The emphasis in this
discussion will therefore be on demand forecasting.

Topic 2: Seven Steps in the Forecasting System

Forecasting follows seven basic steps. These are presented below with examples
based on Disney World’s practices (Heizer, et.al. 2017):

1. Determine the use of the forecast: Disney uses park attendance forecasts to
drive decisions about staffing, opening times, ride availability, and food supplies.
2. Select the items to be forecasted: For Disney World, there are six main parks. A
forecast of daily attendance at each is the main number that determines labor,
maintenance, and scheduling.
3. Determine the time horizon of the forecast: Is it short, medium, or long term?
Disney develops daily, weekly, monthly, annual, and 5-year forecasts.
4. Select the forecasting model(s): Disney uses a variety of statistical models that
we shall discuss, including moving averages, econometrics, and regression
analysis. It also employs judgmental, or nonquantitative, models.
5. Gather the data needed to make the forecast: Disney’s forecasting team
employs 35 analysts and 70 field personnel to survey 1 million people/businesses
every year. Disney also uses a firm called Global Insights for travel industry
forecasts and gathers data on exchange rates, arrivals into the U.S., airline
specials, Wall Street trends, and school vacation schedules.
6. Make the forecast.
7. Validate and implement the results: At Disney, forecasts are reviewed daily at
the highest levels to make sure that the model, assumptions, and data are valid.
Error measures are applied; then the forecasts are used to schedule personnel
down to 15-minute intervals.

Topic 3: Forecasting Time Horizons

A forecast is usually classified by the future time horizon that it covers. Time
horizons fall into three categories (Heizer, et.al. 2017):

1. Short-range forecast: This forecast has a time span of up to 1 year but is

generally less than 3 months. It is used for planning purchasing, job scheduling,
workforce levels, job assignments, and production levels.

2. Medium-range forecast: A medium-range, or intermediate, forecast generally

spans from 3 months to 3 years. It is useful in sales planning, production
planning and budgeting, cash budgeting, and analysis of various operating plans.

3. Long-range forecast: Generally 3 years or more in time span, long-range

forecasts are used in planning for new products, capital expenditures, facility
location or expansion, and research and development.

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 Medium- and long-range forecasts are distinguished from short-range forecasts
by three features (Heizer, et.al. 2017):

 First, intermediate and long-range forecasts deal with more comprehensive

issues supporting management decisions regarding planning and products,
plants, and processes. Implementing some facility decisions, such as GM’s
decision to open a new Brazilian manufacturing plant, can take 5 to 8 years from
inception to completion.
 Second, short-term forecasting usually employs different methodologies than
longer-term forecasting. Mathematical techniques, such as moving averages,
exponential smoothing, and trend extrapolation (all of which we shall examine
shortly), are common to shortrun projections. Broader, less quantitative
methods are useful in predicting such issues as whether a new product, like the
optical disk recorder, should be introduced into a company’s product line.
 Finally, as you would expect, short-range forecasts tend to be more accurate
than longer range forecasts. Factors that influence demand change every day.
Thus, as the time horizon lengthens, it is likely that forecast accuracy will
diminish. It almost goes without saying, then, that sales forecasts must be
updated regularly to maintain their value and integrity. After each sales period,
forecasts should be reviewed and revised.

Topic 4: Forecasting Approaches

There are two general approaches to forecasting, just as there are two ways to
tackle all decision modelling. One is a quantitative analysis; the other is a qualitative
approach. Quantitative forecasts use a variety of mathematical models that rely on
historical data and/or associative variables to forecast demand. Subjective or qualitative
forecasts incorporate such factors as the decision maker’s intuition, emotions, personal
experiences, and value system in reaching a forecast. Some firms use one approach and
some use the other. In practice, a combination of the two is usually most effective
(Heizer, et.al. 2017).

Topic 5: Qualitative Forecasting Methods

Presented below, are four qualitative methods used by various organizations for
forecasting (Heizer, et.al. 2017):

1. Jury of Executive Opinion

Under this method, the opinions of a group of high-level experts or
managers, often in combination with statistical models, are pooled to arrive at a
group estimate of demand.

2. Delphi Method
This is a forecasting technique that uses a group process that allows
experts to make forecasts. There are three different types of participants in the
Delphi method: decision makers, staff personnel, and respondents. Decision
makers usually consist of a group of 5 to 10 experts who will be making the
actual forecast. Staff personnel assist 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

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 judgments are valued. This group provides inputs to the decision makers before
the forecast is made.

3. Sales Force Composite

It is a forecasting technique based on salesperson’s estimates of
expected sales. In this approach, each salesperson estimates what sales will be in
his or her region. These forecasts are then reviewed to ensure that they are
realistic. Then they are combined at the district and national levels to reach an
overall forecast.

4. Market Survey
This method solicits input from customers or potential customers
regarding future purchasing plans. It can help not only in preparing a forecast
but also in improving product design and planning for new products. The
consumer market survey and sales force composite methods can, however,
suffer from overly optimistic forecasts that arise from customer input.

Topic 6: Quantitative Forecasting Methods

Unlike qualitative methods, quantitative forecasting methods use historical date

in order to forecast demand. These methods may be categorized into two, namely:
Time-Series models and Associative models.

Time-series Models predict on the assumption that the future is a function of

the past. In other words, these look at what has happened over a period of time and use
a series of past data to make a forecast (Heizer, et.al. 2017).

On the other hand, Associative Models, such as linear regression, incorporate

the variables or factors that might influence the quantity being forecast. For example,
an associative model for lawn mower sales might use factors such as new housing starts,
advertising budget, and competitors’ prices (Heizer, et.al. 2017).

TIME-SERIES FORECASTING

Time series is based on a sequence of evenly spaced (daily, weekly, monthly,

quarterly, yearly) data points. This forecasting implies that future values are predicted
only from past values and other variables, no matter how valuable, are ignored. There
will be three time-series forecasting models that will be discussed, i.e. naïve approach,
moving averages and weighted moving average.

Naïve Approach
It is the simplest way of time- series forecasting. A forecasting technique which
assumes that demand in the next period is equal to demand in the most recent period
(Heizer, et.al. 2017). Thus, if a bakery was able to sell 1000 pandesal for Monday, the
forecasted demand for Tuesday should be 1000 as well. It turns out that for some
product lines, this naive approach is the most cost-effective and efficient objective
forecasting model. At least it provides a starting point against which more sophisticated
models that follow can be compared (Heizer, et.al. 2017).

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Moving Averages
It is a forecasting method that uses an average of the most recent periods of
data to forecast the next period. It is useful if we can assume that market demands will
stay fairly steady over time (Heizer, et.al. 2017).
Mathematically, moving average can be solved using the formula:

∑ 𝐝𝐞𝐦𝐚𝐧𝐝 𝐢𝐧 𝐩𝐫𝐞𝐯𝐢𝐨𝐮𝐬 𝒏 𝐩𝐞𝐫𝐢𝐨𝐝𝐬

Moving Average =
𝐧

Based from the formula, “n” is the number of periods in the moving average that
will be used for forecasting. To make it clearer, try following the sample forecast below:

***Heizer J., Render B. & Munson C. (2017).OM: Sustainability and Supply Chain Management, 12 th Edition, p. 114

Weighted Moving Average

When a detectable trend or pattern is present, “weights” can be used to place
more emphasis on recent values. This practice makes forecasting techniques more
responsive to changes because more recent periods may be more heavily weighted.
Choice of weights is somewhat arbitrary because there is no set formula to determine
them. Therefore, deciding which weights to use requires some experience. For example,
if the latest month or period is weighted too heavily, the forecast may reflect a large
unusual change in the demand or sales pattern too quickly.
A weighted moving average may be expressed mathematically as:

∑((𝒘𝒆𝒊𝒈𝒉𝒕 𝒇𝒐𝒓 𝒑𝒆𝒓𝒊𝒐𝒅 𝒏)(𝒅𝒆𝒎𝒂𝒏𝒅 𝒊𝒏 𝒑𝒆𝒓𝒊𝒐𝒅 𝒏))

Weighted Moving Average =
∑𝒘𝒆𝒊𝒈𝒉𝒕𝒔

To make it clearer, try following the sample provided.

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 ***Heizer J., Render B. & Munson C. (2017).OM: Sustainability and Supply Chain Management, 12 th
Edition, p. 114

ACTIVITY/ TASK

Answers on the activity/task shall be written on whole sheet/s of yellow paper

and must be submitted not later than the agreed deadline. Late submissions will not
be accepted and will result to a failing grade.

A. Think deeply of what you will become in the future. Make a forecast of yourself
using the different forecasting time horizon, i.e. short-term (after 1 year),
medium-term (after 3 years) and long-term (after 10 years) forecasts. Explain
briefly what made you come up with those predictions.

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ASSESSMENT

PROBLEM SOLVING: Answers shall be written on whole sheet/s of yellow paper and
must be submitted not later than the agreed deadline. Late submissions will not be
accepted and will result to a failing grade. Show your solutions.

1. The Instant Paper Clip Office Supply Company sells and delivers office supplies to
companies, schools and agencies. The manager of the company wants to be
certain that there are always enough inventories of office supplies to be
delivered if needed. So he wants to forecast the demand for the next months.
From the records of previous orders, the management accumulated the
following data for the past 6 months:

Month Actual Sales Weight

May 110 .34
June 50 .46
July 75 .57
August 130 .17
September 110 .33
October 90 .05

a. Forecast the demand for the months of July to November using Naïve
method. (3 points)
b. Forecast the demand for the months of September to November using 3-
months moving average. ((9 points)
c. Forecast the demand for the months of October to November using 5-
months moving average. (8 points)
d. Forecast the demand for the months of October to November using 3-
months weighted moving average. (10 points)
e. Forecast the demand for the months of October to November using 5-
months weighted moving average. (10 points)

RUBRICS FOR WRITTEN OUTPUT

This criterion shall include the reliability and
ingenuity of the output. Its reliability shall be
Content evaluated based on the truthfulness, while 50%
ingenuity indicates the originality and creativity
of the incorporated ideas and concepts.
This criterion encompasses the ways how the
Organization of ideas and concepts are presented. Coherence
30%
Ideas and structure of the content are the focus of the
criterion.
Grammar & This criterion shall include the grammatical
20%
Mechanics correctness, format and use of punctuations.
TOTAL 100%

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