Forecasting What & Why

The Forecast is an estimate of future trends. A forecast can be

determined by mathematical means using historical data; it can be
created subjectively by using estimates from informal sources; or it can
represent a combination of both techniques.

Forecasting enables the future to be visualised, it creates a baseline
against which actual data can be measured. The key in Demand
Planning is to monitor the gaps between the anticipated (forecast) and
the achieved (actual) and then, using forecasting skills and tools reduce
that gap in the next cycle.


What is Forecasting?
Why Forecast ?
There are lots of reasons why Forecasting is a good idea:

...Meet Market Demand...Manage Lead-Times...Reduce Inventory...Avoid Over
Production...Minimise Stock-Outs...Support Budget...Inject Realism...Increase
Buying Power...Schedule Resources...Guide Company Strategy...Define
Promotions...Maintain Price Structure...Measure Awareness of Demand...Drive
Continuous Improvement...Create Stability in the Supply Chain...

To reduce uncertainty

To anticipate change

To improve communication

To increase knowledge

To grow revenues and increase profitability
Characteristics of Forecasting
Accuratesome degree of accuracy should be determined and stated so that
comparison can be made to alternative forecasts.

Reliablethe forecast method should consistently provide a good forecast if
the user is to establish some degree of confidence.

Timelya certain amount of time is needed to respond to the forecast so the
forecasting horizon must allow for the time necessary to make changes.

Easy to use and understandusers of the forecast must be confident and
comfortable working with it.

Cost-effectivethe cost of making the forecast should not outweigh the
benefits obtained from the forecast.


There are three major types of forecasting, which can be broadly described as
macro, meso and micro:

Macro forecasting is concerned with forecasting markets in total. This is about
determining the existing level of Market Demand and considering what will
happen to market demand in the future.

Meso forecasting - Intermediate conceptions of market structures and industry
clusters (i.e. bigger than micro, but smaller than macro) have often used meso
to describe the domain of that problem.

Micro forecasting is concerned with detailed unit sales forecasts. This is about
determining a products market share in a particular industry and considering
what will happen to that market share in the future.

The selection of which type of forecasting to use depends on several factors:
(1) The degree of accuracy required
(2) The availability of data and information
(3) The time horizon that the sales forecast is intended to cover.
(4) The position of the products in its life cycle.
Types of Forecasting
MARKET FORECAST
Definition
A Market Forecast is a core Component of a Market Analysis. It project the
future numbers, characteristics and trends in your Target Market.
Organisations may need to forecast the size and growth of a market or
product category. When strategic issues are being considered, they need to
forecast the actions and reactions of key decision makers such as competitors,
suppliers, distributors, governments, their own actions, and complementors'
(organizations with whom they cooperate) actions.

AIRBUS GLOBAL MARKET FORECAST 2011-2030

The latest Airbus Global Market Forecast provides an industry outlook
through 2030, with an emphasis on such drivers and factors as fleet growth,
aircraft size, emerging markets, innovation and environmental impact.
During this period, Airbus foresees the need for more than 26,900 passenger
airliners with seating capacities of 100 seats and above, along with over 900
new factory-built freighter aircraft. In the same timeframe, the worlds
overall passenger aircraft inventory will more than double from todays
15,000 to more than 31,500 by 2030.

Exhibit 1. A framework for marketing forecasts.
Environment
Sales
Actions by Suppliers,
Distributors and Government
Competitors
(Market Mix)
Company
(Market Mix)
Market Share
Sales
Impact on Stakeholders (eg. Profits)
Cost
SALES FORECAST
Definition
Sales forecasting is a difficult area of management. Most managers believe they
are good at forecasting. However, forecasts made usually turn out to be wrong!
Marketers argue about whether sales forecasting is a science or an art. The short
answer is that it is a bit of both.

Reasons for undertaking sales forecasts

Businesses are forced to look well ahead in order to plan their investments,
launch new products, decide when to close or withdraw products and so on.
The sales forecasting process is a critical one for most businesses. Key decisions
that are derived from a sales forecast include:

Employment levels required
Promotional mix
Investment in production capacity

Sales Potential and Forecasting
The Historical Perspective - As a starting point, management analyzes
previous sales experience by product lines, territories, classes of customers,
or other relevant categories.

Market Position - Forecasting may also consider how the company rates
against its competitors in terms of market share, research and development,
quality, pricing and sales financing policies, and overall public image.

Price Index - If prices for products have changed significantly over the years,
changes in Rupee volume of sales may not correlate well with unit sales. To
adjust for such discrepancies, a price index may be developed showing the
relative prices of goods for a given year versus some reference year.

Product Trend - Forecasters may also analyze sales trends of individual
products. This may include the use of price indexes. Such trends are
important for understanding product life cycles and separating the
performance of similar products (e.g., two different lines of shampoo from
the same company) to evaluate strengths and weaknesses.

Developing a Sales Forecast
Determine the purposes of the forecast (e.g., for purchasing, strategic
planning, etc.).
Divide the company's products into homogeneous (or at least relevant)
categories.
Determine the major factors affecting the sales of each product group and
their relative importance.
Choose one or more forecasting methods based on the kind of data
available and the sophistication needed in the forecast.
Gather all necessary data.
Analyse the data.
Check and cross-check any adjustments to the data (e.g., price indexing or
seasonal adjustments).
Make assumptions regarding any effects of the various factors that can't be
measured or forecast.
Convert deductions and assumptions into specific product and territorial
forecasts and quotas.
Apply forecasts to company operations.
Periodically review performance and revise forecasts.
DEMAND FORECAST
Definition
Demand forecasting is the activity of estimating the quantity of a product or
service that consumers will purchase. Demand forecasting involves techniques
including both informal methods, such as educated guesses, and quantitative
methods, such as the use of historical sales data or current data from test
markets. Demand forecasting may be used in making pricing decisions, in
assessing future capacity requirements, or in making decisions on whether to
enter a new market.

Stock effect - The effects that inventory levels have on sales. In the extreme
case of stock-outs, demand coming into your store is not converted to sales
due to a lack of availability. Demand is also untapped when sales for an item
are decreased due to a poor display location, or because the desired sizes are
no longer available.

Market response effect - The effect of market events that are within and
beyond a retailers control. Demand for an item will likely rise if a competitor
increases the price or if you promote the item in your weekly circular. The
resulting sales a change in demand as a result of consumers responding to
stimuli that potentially drive additional sales. Regardless of the stimuli, these
forces need to be factored into planning and managed within the demand
forecast
FORECASTING METHODS
Forecasting Methods
Qualitative Techniques

Qualitative forecasting techniques are subjective, based on the opinion and
judgment of consumers, experts; appropriate when past data is not available. It is
usually applied to intermediate-long range decisions.

Delphi Method - uses a panel of experts to produce a forecast. Each expert is
asked to provide a forecast specific to the need at hand.
Nominal Group Technique - Nominal Group Technique is similar to the
Delphi technique in that it utilizes a group of participants, usually experts.
After the participants respond to forecast-related questions, they rank their
responses in order of perceived relative importance.
Sales force Opinion - The sales staff is often a good source of information
regarding future demand.
Executive Opinion - Sometimes upper-levels managers meet and develop
forecasts based on their knowledge of their areas of responsibility.
Market Research - In market research, consumer surveys are used to establish
potential demand.


CONTD

Quantitative Techniques - models are used to estimate future
demands as a function of past data; appropriate when past data is available. It
is usually applied to short-intermediate range decisions.

Last period demand
Arithmetic Average - often referred to as simply the mean or average when
the context is clear, is a method to derive the central tendency of a sample
space
Simple Moving Average (N-Period) - is formed by computing the average
price over a specific number of periods. Most moving averages are based on
closing prices. A 5-day simple moving average is the five day sum of closing
prices divided by five.
Weighted Moving Average (N-period) - A weighted average is any average
that has multiplying factors to give different weights to data at different
positions in the sample window.
Simple Exponential Smoothing - Exponential smoothing is a technique that
can be applied to time series data, either to produce smoothed data for
presentation, or to make forecasts.


CONTD
Time Series - is the use of a model to forecast future events based on
known past events to predict data points before they are measured. Time series
are very frequently plotted via line charts.

A time series model will generally reflect the fact that observations close
together in time will be more closely related than observations further apart. In
addition, time series models will often make use of the natural one-way
ordering of time so that values for a given period will be expressed as deriving
in some way from past values, rather than from future values

A time series is a set of statistics, usually collected at regular intervals. Time
series data occur naturally in many application areas.

economics - e.g., monthly data for unemployment, hospital admissions, etc.
finance - e.g., daily exchange rate, a share price, etc.
environmental - e.g., daily rainfall, air quality readings.
medicine - e.g., ECG brain wave activity every 28 secs.
CONTD
Sensitivity Analysis - Sensitivity analysis (SA) is the study of how the
variation (uncertainty) in the output of a statistical model can be attributed to
different variations in the inputs of the model.

Put another way, it is a
technique for systematically changing variables in a model to determine the
effects of such changes.
In more general terms uncertainty and sensitivity analysis investigate the
robustness of a study when the study includes some form of statistical
modelling. Sensitivity analysis can be useful to computer modelers for a range
of purposes,

including:
Support decision making or the development of recommendations for
decision makers (e.g. testing the robustness of a result);
Enhancing communication from modellers to decision makers (e.g. by
making recommendations more credible, understandable, compelling or
persuasive);
Increased understanding or quantification of the system (e.g. understanding
relationships between input and output variables); and
Model development (e.g. searching for errors in the model).


CONTD
Expert Opinion or Judgmental Method - These methods rely on
expertise and intuition, rather than on statistical analysis of historical data. Such
methods are particularly useful when historical data is scarce. Many of the
methods of futurismsuch as the Delphi method, visioning and scenario
buildingfall under this category.
Composite forecast the conceptual framework for forming optimal
composite forecast, considers alternative methods of forming composites,
and attempts to identify circumstances when composite forecast might work
best.
Surveys - Survey methodology is the field that studies surveys, that is, the
sample of individuals from a population with a view towards making
statistical inferences about the population using the sample
Delphi Method - is a structured communication technique, originally
developed as a systematic, interactive forecasting method which relies on a
panel of experts.
Scenario analysis is a process of analyzing possible future events by
considering alternative possible outcomes
Forecast by analogy is a forecasting method that assumes that two different
kinds of phenomena share the same model of behaviour.
Trend Extrapolation - There are many techniques used to project past
data into the future. These tend to be powerful forecasting techniques that are
sometimes subject to unforeseen events.
Trends are often shown graphically (as line graphs) with the level of a
dependent variable on the y-axis and the time period on the x-axis. There are
different "levels" of trends:
Constant trends are those where there is no net increase or decrease.
Linear trends show a steady, straight-line increase or decrease. So the trend
line may go up or down, and the angle may be steep or shallow.
Exponential trends are those where the data rises or falls not at a steady rate,
but at an increasing rate. The x-value (plotted horizontally) is an exponent of
the trend line formula to derive the y-value.

Trend Correlation - the forecaster assumes that "one factor is the
primary causal influence in the advancement of the technological parameter of
interest." Trend correlation analysis is optimal for situations where the
development of a certain innovation lags the development of another
innovation.


CONTD
CONTD
Econometric Model- are statistical models used in econometrics. An
econometric model specifies the statistical relationship that is believed to hold
between the various economic quantities pertaining a particular economic
phenomenon under study.

A simple example of an econometric model is one that assumes that monthly
spending by consumers is linearly dependent on consumers' income in the
previous month. Then the model will consist of the equation

C
t
= a + bY
t 1
+ e
t
,

where C
t
is consumer spending in month t, Y
t-1
is income during the previous
month, and e
t
is an error term measuring the extent to which the model cannot
fully explain consumption.



CONTD
Cross Impact Analysis - The cross impact model was introduced as a
means of accounting for the interactions between a set of forecasts, when those
interactions may not have been taken into consideration when individual
forecasts were produced. The origin of cross-impact analysis was the problem
that Delphi panellists were sometimes asked to make forecasts about individual
events, when other events in the same Delphi could affect these events.

Demand/ Hazard Forecasting - researchers identity major events that
would greatly affect the firm. Each event is rated for its convergence wit several
major trends taking place in society an for its appeal to each public group in the
society. The higher scoring events are then researched further.



CASE STUDY
How to incorporate Market Intelligence into
statistical forecasting

The 14
th
World Conference on Earthquake
engineering
Social Impacts of Incorrect Decisions from
Earthquake forecasting