Forecasting

Managerial Economics
Sources: Operations Management by William Stevenson;
Quantitative Analysis for Management, Eleventh Edition, Global Edition
by Render, Stair, and Hanna; PPT slides by Brian Peterson
Managerial Economics Application Strategies and Tactics

Lecturer: Marian V. Reyes

Agenda
5.1 Introduction
5.2 Types of Forecasts
5.3 Time-Series Forecasting Models
5.4 Measures of Forecast Accuracy
5.5 Monitoring and Controlling Forecasts
5.6 Summary
Business and Economic Forecasting
Chapter 5
Demand Forecasting is a critical
managerial activity which comes in two
forms:
 Quantitative Forecasting +2.1047%
Gives the precise amount
or percentage
 Qualitative Forecasting
Gives the expected direction
Up, down, or about the same
2005 South-Western Publishing
What Went Wrong With
SUVs at Ford Motor Co?
● Chrysler introduced the Minivan

○ in the 1980’s
● Ford expanded its capacity to produce the Explorer, its popular SUV
● Explorer’s price was raised substantially in 1995 at same time competitors
expanded their offerings of SUVs.
● Must consider response of rivals in pricing decisions
 Introduction Uses of Forecast
FORECAST:
• A statement about the future value of
a variable of interest such as demand.
• Forecasts affect decisions and
activities throughout an organization
· Accounting, finance
· Human resources
· Marketing
· MIS
· Operations
· Product / service design
 Introduction Elements of a Good Forecast
1. Timely
• Assumes causal system past ==> future 2. Reliable
• Forecasts rarely perfect because of 3. Accurate
Randomness 4. Meaningful
• Forecasts more accurate for groups vs.
5. Written/Documented
individuals
• Forecast accuracy decreases as time 6. Easy to Use
horizon increases
Significance of Forecasting

● Both public and private enterprises operate under conditions

of uncertainty.
● Management wishes to limit this uncertainty by predicting
changes in cost, price, sales, and interest rates.
● Accurate forecasting can help develop strategies to promote
profitable trends and to avoid unprofitable ones.
● A forecast is a prediction concerning the future. Good
forecasting will reduce, but not eliminate, the uncertainty that
all managers feel.
 Introduction 8 Forecasting Steps
1. Determine the use of the forecast
● Managers are always trying to 2. Select the items or quantities that are to be
reduce uncertainty and make better forecasted
estimates of what will happen in the 3. Determine the time horizon of the forecast
future
● Some firms use subjective 4. Select the forecasting model or models
methods while others use several 5. Gather the data needed to make the
quantitative techniques forecast
● Different organizations may use 6. Validate the forecasting model
different techniques and whatever
tool works best for a firm is the one 7. Make the forecast
they should use 8. Implement the results
Types of Forecasts
• Judgmental or Qualitative - uses subjective
inputs
• Time series or Quantitative - uses historical
data assuming the future will be like the past
• Associative models or Causal - uses
explanatory variables to predict the future
Types of Forecasts and Forecasting Models
Judgemental or Qualitative Models
Qualitative models incorporate judgmental or subjective factors
Common qualitative techniques are:
1. Delphi Method – an iterative group process where (possibly
geographically dispersed) respondents provide input to decision
makers
2. Jury of Executive Opinion – collects opinions of a small group of
high-level managers, possibly using statistical models for analysis
3. Sales Force Composite – individual salespersons estimate the
sales in their region and the data is compiled at a district or
national level
4. Consumer Market Survey – input is solicited from customers or
potential customers regarding their purchasing plans
Time-Series Models Causal Models
Time-series models attempt to Causal models use variables or
predict the future based on the factors that might influence the
past quantity being forecasted
Common time-series models are: The objective is to build a model with
1. Moving average the best statistical relationship
2. Exponential smoothing between the variable being forecast
3. Trend projections and the independent variables
4. Decomposition Regression analysis is the most
5. Regression analysis is used in common technique used in causal
trend projections and one type of modeling
decomposition model
Time Series Forecasting Models
Time series forecasts predict the future based Components of Time Series
solely of the past values of the variable other Model:
variables are ignored
1.Trend (T) is the gradual upward
or downward movement of the
There are two general forms of time-series models: data over time
Multiplicative model: Demand = T x S x C x R 2.Seasonality (S) is a pattern of
Additive model: Demand = T + S + C + R demand fluctuations above or
below trend line that repeats at
regular intervals
3.Cycles (C) are patterns in
annual data that occur every
several years
4.Random variations (R) are
“blips” in the data caused by
chance and unusual situations
Time Series - Naive Forecasts Models
Uses for Naïve Forecasts
● Naïve Forecasts - the forecast
for any period equals the 1. Stable time series data
F(t) = A(t-1)
previous period’s actual value 2. Seasonal variations
○ Simple to use F(t) = A(t-n)
○ Virtually no cost 3. Data with trends
○ Quick and easy to prepare F(t) = A(t-1) + (A(t-1) – A(t-2))
○ Data analysis is nonexistent
○ Easily understandable
○ Cannot provide high accuracy
Time Series – Averaging Techniques
● Moving average – A technique that averages a number of
recent actual values, updated as new values become
available.
● Weighted moving average – More recent values in a
series are given more weight in computing the forecast.
● Exponential smoothing - Weighted averaging method
based on previous forecast plus a percentage of the
forecast error
Guide Questions
● What type of forecast uses subjective inputs and is also known as
Judgmental?
● What type of forecast uses historical data and also known as time-series?
● What type of judgmental forecast collects opinion from a small group of high-
level managers, possibly using statistical models for analysis?
● What is an iterative group process where respondents provide input to
decision makers?
● What is a pattern of demand fluctuations above or below trend line that
repeats at regular intervals?