Production and Operations Management

Unit 4

Unit 4
Structure: 4.1 Introduction Objectives 4.2 What is Forecasting? 4.3 The Strategic Importance of Forecasting Human resources Capacity Supply chain management 4.4 Why Forecasting is required? Benefits from forecasts Cost implications of forecasting Decision making using forecasting 4.5 Classification of Forecasting Process 4.6 Methods of Forecasting 4.7 Case-let 4.8 Forecasting and Product Life Cycle 4.9 Selection of the Forecasting Method 4.10 Qualitative Methods of Forecasting 4.11 Quantitative Methods What is time series? Nave method Moving average method Weighted moving average Exponential smoothing method 4.12 Associative Models of Forecasting 4.13 Accuracy of Forecasting Mean Absolute Deviation (MAD) Standard Error (SE) of estimate 4.14 Summary 4.15 Glossary 4.16 Terminal Questions 4.17 Answers 4.18 Case Study

Forecasting

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Before we start forecasting, take a look at these famous quotes: With over 50 foreign cars already on sale here, the Japanese auto industry isn't likely to carve out a big slice of the U.S. market. Business Week, 1958. I think there is a world market for about five computers. Thomas J. Watson, 1943, Chairman of the Board of IBM. Do you want to forecast? ____________________________________________________________

4.1 Introduction
In the previous unit, we have dealt with the concepts of operations strategy, competitive capabilities and core competencies, operations strategy as a competitive weapon, linkage between corporate, business, and operations strategy, developing operations strategy, elements or components of operations strategy, competitive priorities, manufacturing strategies, service strategies, and global strategies and role of operations strategy. In this unit, we will deal with the concepts of forecasting, the strategic importance of forecasting, why forecasting is required, classification of forecasting process, methods of forecasting, forecasting and product life cycle, selection of the forecasting method, qualitative and quantitative methods of forecasting, associative models of forecasting, and accuracy of forecasting. Every business activity aims to satisfy some needs and wants of the society and hence tries to gauge the demand. Only when the demand is properly understood and predicted with sufficient accuracy, it becomes possible to develop and utilise the resources to cater to such demands. Thus, for any business activity to be started, the first step would be to predict the demand and then to develop the plans towards meeting the demand either partially or fully. Hence, it is correctly said that forecasting the demand is the first step and demand forecasting drives all the other activities of production systems which include human resource planning, aggregate planning, capacity planning, and scheduling. Even if a company decides to position itself in a certain way, it has to have done forecasting. Thus good forecasts are of critical importance in all aspects of a business.

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The forecast is the only estimate of demand until the actual demand becomes known. However, forecasts are seldom perfect because the demand for a certain product or service is a complex function influenced by a multitude of variables. Many of these variables are not controllable and even not properly evaluated in terms of magnitude and frequency. This means that outside factors which are not known to us or properly predicted or controlled impact the forecast tremendously. Hence, it is essential to allow for this reality. In other words, expecting an accurate forecast is selfdefeating. Most forecasting techniques assume that there is some underlying stability in the system, which is not the case always. Hence, product family and aggregated forecasts are more accurate than individual product forecasts. Objectives: After studying this unit, you should be able to: define forecasting explain the importance of forecasting explain when to use the qualitative models apply the different methods of forecasting and compare the results compute the measures of forecast accuracy identify special cases like causal and seasonal models use a tracking signal for checking the accuracy and efficiency of forecasting

4.2 What Is Forecasting?

As stated in Heizer and Render (2010), forecasting is the art and science of predicting the future events. Forecasting is an art because subjective assessment coupled with historical and contemporary judgment is required to improve the accuracy of forecasts. It is a science because a wide variety of numerical methods are used to obtain a number or several numbers and further analysed using mathematical models to ascertain the accuracy of forecast. In most of the cases, forecasting may involve taking historical data and projecting them into the future with some sort of mathematical model. It may be a subjective or an intuitive prediction. Many times, the forecasting may
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even resemble a kind of a wild guess or may involve extensive data analysis involving several parameters. Sometimes, it may involve a combination of a mathematical model adjusted by a managers good judgment. Forecasting is synonymous with estimating and prediction, though forecasting is considered to be more scientific rather than a crude or vague guesswork.

4.3 The Strategic Importance of Forecasting

Forecast is very much required for all types of industrial activity and also for those industries which are purely in the service sector like healthcare and education. Good forecasts are of critical importance in all aspects of a business: The forecast is the only estimate of demand until the actual demand becomes known. Therefore, forecast is said to drive decisions in many business areas. Forecast influences three key activities. They are: Human resources Capacity Supply chain management Let us now discuss these three activities in detail. 4.3.1 Human resources Typically, the number of persons required is a function of the production output which, in turn, depends on demand forecasting. Hence hiring, training, and laying off workers, all depend on the anticipated demand. When fresh workers are hired anticipating a rise in the demand, it is expected that they can quickly get into the required job. However, training is required apart from developing good relations with the existing workers. Similarly, if workers are removed, it sets a demoralising atmosphere. Further, the removed workers will spread the news, and the industry will suffer due to bad reputation and poor image. 4.3.2 Capacity Capacity refers to the ability to meet the demand in terms of resources and the preparedness on the part of the company. When the demand pattern is well recognised and indicates a rise, the capacity build up happens and ensures that there are no lost sales for want of product. On the other hand, if the demand is showing a decline, it signals a decrease in capacity. Thus,
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unnecessary investments are not made. Both for capacity-lead and capacity-lag decisions, demand forecasting is vital. 4.3.3 Supply chain management Supply chain management refers to all the activities that enable the right product at the right place at the right price. Hence, demand forecasting has to be done with utmost care to help identifying the vendors, pricing choices, and material options. When the demand is properly forecasted, it is easy to plan for the suppliers, logistics, and other intermediaries to ensure the delivery of the product at the right time. Self Assessment Questions 1. Forecasting is both art and science of predicting the future events. (True/ False) 2. Demand forecasting is vital both for capacity-lead and capacity-lag decisions. (True / False) 3. Forecasts are not always perfect because the demand for a certain product or service is a complex function influenced by a multitude of variables. (True / False)

4.4 Why Forecasting is required?

Forecasting is required for: Production planning Financial planning Personnel planning Scheduling planning Facilities planning Process design and planning 4.4.1 Benefits from forecasts Forecasting basically helps to overcome the uncertainty about the demand and thus provides a workable solution. Without the forecast, no production function can be taken up. Hence, it can be stated that forecasting helps to: Improve employee relations Improve materials management Get better use of capital and facilities Improve customer service
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4.4.2 Cost implications of forecasting Forecasting requires special efforts and involves inputs from experts which cost a lot to the companies. Well-trained experts and associations substantially invest in human resources and hence charge their clients for the service rendered. Thus, forecasting done in-house or carried out externally requires significant investments. Thus, it can be said that more the efforts put for forecasting, more will be the cost of forecasting. Because of improved accuracy and better judgment, the losses that would occur because of poor forecasting would decrease as more efforts are put in for forecasting. Hence, higher the efforts, lower will be the losses. Because effort is a direct function of forecasting, this cost goes up with increase in the forecasting efforts. Figure 4.1 depicts the forecasting cost implications graphically.

Fig. 4.1: Forecasting Cost Implications

From figure 4.1, it is to be understood that to keep the total cost of forecasting to a minimum, it is necessary that the forecasting effort has to be raised up to a level at which certain uncertainty is acceptable and hence, there is preparedness for some possible loss. On the other hand, it doesnt make sense to increase the effort to improve the accuracy of forecasting because the forecasts are subject to market dynamics and many other unpredictable parameters which will not be known or controllable. For
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example, the governments import policy drastically affects the capacity and thus any industry hoping of increasing the demand and expanding the capacity will face a major threat and possible loss. 4.4.3 Decision making using forecasting Forecasts are always subject to uncertainty because of the changing environment and hence, any attempt to improve the forecast accuracy only increases the cost but not the accuracy. Keeping this in mind, the managerial decision makers adopt the following rule: Actual decision = Decision assuming forecasting is correct + Allowance for forecast error. Further to account for the uncertainty and provide allowance, it is necessary that the forecast output contains two numbers as follows: 1) Best estimate of the demand + 2) Error Again the question, how much of error can creep in the forecast? It is difficult to answer. However, the error in forecast is easy to calculate once the actual demand is known. Forecast error = Actual demand - Forecast demand Figure 4.2 depicts the process of forecasting and the associated factors.

Fig. 4.2: Forecast Generation and Revision

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What is being forecasted is called as the variable of interest In the forecasting jargon, traditionally, it is assumed that it is the demand that is always connected with sales. However in a general way, forecast may refer to several things including the outcome of any process, naturally occurring or created for a specific purpose. For example, election results, material requirement, population, economic growth, weather, and even tourists visiting a certain place. Further, while forecasting, it helps to ask the following to improve the accuracy of forecast: Input elements involved Process generating the variable Availability of data Stability of the process Accuracy of data Adequacy of data Representativeness of the data

4.5 Classification of Forecasting Process

According to Heizer and Render (2008), the forecasting methods can be classified based on the context or focus. The different forecasting methods are discussed below. Based on the type of database, the forecasting methods can be classified into 2. They are: Quantitative (Statistical forecasting) Qualitative (Subjective estimation) Based on the forecast time period, the forecasting methods can be classified into 3. They are: Short range up to 1 year Medium range 1 to 3 years Long range 5 years or more Based on the methodology, the forecasting methods can be classified into 3. They are: Time series methods Causal methods Predictive methods (Qualitative methods)
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Let us now discuss these methods in brief. When forecasting for an existing product or similar to it, historical data will be available and hence statistical methods can be applied. These include simple time series models to very extensive methods like response surface methodology. If no numerical data is available, then the opinion-based data containing qualitative descriptions like good, bad, acceptable, etc will have to be used. Also in some methods, the experts opinion or panels comments will be used. Regarding the time horizon, it is obvious that some elements or variables of interest will have to be predicted over long ranges like housing development or global warming effects. In some cases, particularly for short periods, some parameters like fuel prices, material availability, labour availability, etc have to be predicted. Keeping these situations, several methods of forecasting have been proposed and not all of them will be relevant or useful under all situations. Thus, the decision maker has to make a careful evaluation of all the choices before choosing the method. Self Assessment Questions 4. Forecasting basically helps to overcome the ________ about the demand and thus provides a workable solution. 5. Forecasting whether done in-house or carried out externally requires significant investments. (True / False) 6. Forecast error = ___________ - Forecast demand.

4.6 Methods of Forecasting

The different methods of forecasting can be classified as follows: Qualitative methods Market surveys Nominal group testing Historical analysis Jury of executive opinion Life cycle analysis Delphi method

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Quantitative methods
Table 4.1: Quantitative methods classification

Time series analysis Moving averages Exponential moving averages Box Jenkins method Trend projections Fourier series

Causal methods Regression analysis Input output model Leading indicators Simulations model Economic models

4.7 Case-let
Demand for Light Commercial Vehicles (LCV) in India At present, Tata Motors dominates the market of LCV in India with a market share of about 52% owing the success largely to their model, Tata Ace. Mahindra group enjoys around 25% and the other players are Ashok Leyland, Piaggio, and Eicher Motors. The demand for LCVs is affected by rising interest rates, decreasing industrial output, and a considerable increase in the vehicle prices. The operating cost and environment too have changed significantly affecting the sales. In view of the decreasing demand, the manufacturers have to face the challenge of reduced capacity utilisation. With freight rates almost stagnant, the market seems to be dull in the short run. However, the long-term growth holds promise as there will be economic changes. The LCV industry is expected to grow by 17-18% in the financial year 2011-12. According to the research conducted by J.D. Power Asia Pacific, India will be the third largest LCV market by 2020. The report also says that given Indias poor road infrastructure and concerns about fuel consumption, micro-van and mini truck models in the LCV segment are likely to be popular.
(Source: Patel, J, LCV Industry Begging to Differ, Business India, 4 march 2012, page 30)
th

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Discussion Questions: a. What forecasting method might be suitable for the LCV segment? b. How do you differentiate between poor growth in the short term and promising growth in the long term?

4.8 Forecasting and Product Life Cycle

The demand for a product keeps changing as it passes through different stages in its life cycle. The demand starts with zero value and keeps rising as the product moves along the life cycle and gradually diminishes once the product is outdated or obsolete. For example, iPad and iPhone are currently in the growth stage and hence, the forecast can be trend based and on the rise. But a product like a fixed telephone instrument is in the decline stage and already being phased out. Hence, its forecast has to be carefully done keeping in mind the decreasing sales. If methods are applied mechanically without observing the current stage of the product, the forecast is bound to be erroneous and leads to catastrophe. Figure 4.3 depicts the product life cycle and volume of demand graphically.

Fig. 4.3: Product Life Cycle and Volume of Demand Sikkim Manipal University Page No. 78

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Similarly, many of the web or internet-based transactions like online broking, mail ordering, voice messaging, and online banking are witnessing a surge in the demand and more people will start availing the service. In the banking sector, the IT-enabled services are growing rapidly and hence have decreased the demand for staff. Hence, when forecasting in such cases, people need to understand the possible life left in the product and estimate the demand. Further, there are also instances where the new product has not gone through all the stages but became a failure after it was launched. For example, pagers had a short life before giving way to mobile phones.

4.9 Selection of the Forecasting Method

Given the fact that several methods are available, the question is how to select the right method for forecasting. Because cost, time, and skills are involved, the choice of a forecasting method is based on several factors. They are: Form of forecast required Forecast horizon, period, and interval Data availability Accuracy required Behaviour of process being forecasted (demand pattern) Cost of development, installation, and operation Case of operation Management comprehension and cooperation

4.10 Qualitative Methods of Forecasting

The different qualitative methods of forecasting are as follows: Market surveys Nominal group testing Historical analysis Jury of executive opinion Life cycle analysis Delphi method
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Let us now discuss these qualitative methods in detail. Market surveys Conducting surveys among the prospective buyers or users is a very old method of forecasting. Here, a questionnaire is prepared and circulated among the people and their responses are obtained. The responses are collated and analysed to reveal possible clues towards acceptance or otherwise about a new product or service. Based on the overall decision, the forecasting is done. This method is typically done for new products or at new places where a product is to be launched. In this method, the number of respondents and how responses are gathered like through oral interviews, personal talks, internet based, postal ballots, etc, have to be established before survey. The common limitations are the sample size and the way of drawing the sample like random, convenient, or judgmental. Sample bias is not completely ruled out. Nominal group testing In the nominal group testing method, the product or service may be given a trial use to a specified group like students, employees, neighbors, etc and their responses are collected and analysed. Historical analysis The historical analysis method is based on the fact that the past is an indicator of the future. People try to associate the events that happened earlier with the events that are likely to happen in the future. Jury of executive opinion In the jury of executive opinion method, the opinion of a group of experts is collected and used as an estimate to obtain the forecast. Life cycle analysis In the life cycle analysis method, an assessment of the life cycle stage in which the product lies is made first and an opinion is formed. Delphi method In the Delphi method, the experts give their opinions which are collected by the coordinator and several rounds of discussion may be held before a consensus is reached. This forms the basis for forecasting.

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4.11 Quantitative Methods

Under the quantitative methods, adequate data is collected and different statistical techniques are applied to reveal some patterns which will serve as forecast. Because these methods heavily rely upon the data, it is essential that the collected data is free from errors and bias so that proper conclusions can be made. Another advantage is the availability of several softwares including MS Excel which help to analyse the data extensively which makes these methods easy to learn and apply. The quantitative methods are divided into two groups. They are time series analysis and causal methods.
Table 4.2: Classification of Quantitative methods

Time series analysis Moving averages Exponential moving averages Box Jenkins method Trend projections Fourier series

Causal methods Regression analysis Input output model Leading indicators Simulations model Economic models

In the time series methods, one set of data or several sets are analysed to obtain the forecast. In the causal methods, the association between two variables forms the basis for forecasting. 4.11.1 What is a time series? A time series is defined as a set of values pertaining to a variable collected at regular intervals (weekly, quarterly, or yearly). For example, the temperature recorded every one hour is time series. Similarly, the annual rainfall or agricultural output forms a time series. However, it is to be noted that to draw a reasonable conclusion, at least observations should be available. With very little number of values, say 7 or 8, the forecasts will not be accurate. A time series consists of four components namely: 1) Trend 2) Cyclic 3) Seasonality 4) Random
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Let us now discuss these components in brief. Trend refers to the gradual upward or downward movement of data over a long period of time. Cycles are repetitions of data in a certain pattern at regular intervals like several years. Business cycles are very commonly used to understand the mood of the markets. Seasonal pattern is also a repetitive pattern but observed at much lesser frequency. The season length could be every hour in a day, a day, a week, or months. Variations are noticed at each time period and patterns are observed. Random variations are difficult to predict and are caused by chance factors or unusual events. For example, tsunami wrecked the tourist inflow at several popular holiday destinations all over the world. Figure 4.4 depicts the four components of a time series.

Fig. 4.4: Components of a Time Series

4.11.2 Nave method In the naive method, a set of observations pertaining to a certain variable like sales, production, or consumption is observed and the forecast is taken as the same value as that of the most recent period.

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For example, as stated in www.icra.in the number of small car offerings is given in the table 4.3 below.
Table 4.3: Number of small car offerings 1 Year Number of small car offerings 2007 9 2 2008 14 3 2009 17 4 2010 23 5 2011 26 6 2012 31 7 2013 35

The forecast as given by ICRA is 35 for the year 2013.

Fig. 4.5: Graph showing number of small car offerings

Using the nave method, the forecast for the year 2013 is 31. 4.11.3 Moving average method A moving average is obtained by summing and averaging the values of a time series over a given number of periods repetitively, each time deleting the oldest value and adding a new value. Usually, the number of time periods chosen will be an odd number like 3 or 5 or 7. Rarely, there will be a need to go beyond 7 periods. Consider the same example as given before. The three-year moving average for the first three periods = (9+14+17)/3 = 13.33
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Every time an old period data is dropped and the new period data is included to get the average. Therefore, the next three-year moving average = (14+17+23)/3 = 18 This calculation is continued. Similarly, the five-year moving average for the first five periods = (9+14+17+23+26)/5 = 17.8 The next five-year moving average = (14+17+23+26+31)/5 = 22.2
Table 4.4: Moving averages 1 Year Number of small car offerings Moving average 3 periods Moving average 5 periods 2007 9 2 2008 14 3 2009 17 13.333 4 2010 23 18 5 2011 26 22 17.8 6 2012 31 26.667 22.2 7 2013 35 30.667 26.4

To decide upon the number of time periods, the following guide line may be used: (AP = Averaging Period)
Table 4.5: Guide line Noise Dampening Ability AP = 3 AP = 5 AP = 7 Low Medium High Impulse Response High Medium Low Accuracy Low High Medium

Noise dampening refers to the ability to smooth out the variations. Impulse response enables to detect immediate changes and accuracy implies minimum forecast error. Drawbacks of moving average methods: All the past periods in the averaging period are weighted equally No provision is made for seasonal patterns
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Several periods of historical data must be carried forward from period to period for calculating the forecasts

4.11.4 Weighted moving average In the simple moving average, all the past periods in the averaging period are weighted equally and hence, the forecast is sometimes influenced by bigger values. Secondly, older values are not relevant, particularly in the changing environments. Hence, to reflect those changes, the simple moving average method is modified by using different weights to different time periods. A weighted average generally gives more weight to recent observations than older ones. This has an advantage over simple moving averages that, older values are given less importance than more recent values of a series and that the number of values included in the average can be large while still achieving responsiveness to changes through judicious selection of weights. However, the choice of weights is somewhat arbitrary and is often based on trial and error approach. For example consider the following data:
Table 4.6: Data showing the sales for six months

Month Jan Feb Mar Apr May June

Sales in lakhs of Rupees 90 70 80 85 82 ?

Simple moving average (4 months average) Forecast for the month of June = [70+80+85+82] = 79.25 lakh of Rupees Here the weights are = 1/4 for all the values. Weighted moving average (Using weights 0.1, 0.2, 0.3, 0.4) Forecast for the month of June = 0.1 X 70 + 0.2 X 80 + 0.3 X 85 + 0.4 X 82 = 81.3 lakh of rupees This simple modification to the moving average method allows forecasters to specify the relative importance of past periods of data.
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4.11.5 Exponential smoothing method This method is a modified weighted moving average method using weights in an exponentially increasing way. The name exponential smoothing is derived from the way the weights are assigned to historical data: The most recent values receive most of the weight and weights decrease exponentially as we go back in the periods. Each new forecast is based on the previous forecast plus a percentage of the difference between that forecast and the actual value of the series at that point. New forecast = Old forecast + [Actual value - old forecast value] Where = a percentage and (actual old forecast) = an error Mathematically, Ft =Ft-1 + (At 1 Ft-1) Where Ft = Forecast for the period t Ft-1 = forecast for the period (t-1) = Smoothing constant, varying from 0 to 1 At-1 = Actual value for the period (t-1) Typically values of range from 0.01 to 0.50. Higher values of respond more rapidly to any discrepancies, i.e., the changes in time series are more closely tracked by higher values of . One important limitation of simple exponential smoothing is that it is ill suited for data that includes long-term upward or downward movements (i.e. trend). Use of simple exponential smoothing in such instances would produce forecasts that are too low for upward movements and too high for downward movements. Therefore, when trend is present in time series data, simple exponential smoothing should not be used, instead, exponential smoothing adjusted for trend should be used. Exponentially weighted moving averages is the term used for exponential smoothing. Sometimes is calculated as 2/(AP +1), where AP = Averaging Periods Exponential smoothing methods have been further extended to include other possible variations and two such methods are: 1. Double Smoothing 2. Box Jenkins methods These methods are beyond the scope of the present topic.
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Self Assessment Questions 7. Forecasting is broadly classified as __________ and _____________. 8. Delphi method is a _________ method of forecasting. 9. A _________ is defined as a set of values pertaining to a variable collected at regular intervals (weekly, quarterly, or yearly). 10. The ________ method of forecasting is based on the fact that the past is an indicator of the future

4.12 Associative Models of Forecasting

The methods earlier discussed analysed the data pertaining to a single variable and applying statistical methods developed the forecast. But in industries, it has been observed that there are many situations where the data values of one variable have some association with the data values of another variable. Though this is not exactly a cause and effect situation, it is possible to find out the extent of association and hence, when one variables value is known, the value of the other variable can be estimated using the mathematical relationship. Correlation and regression analyses are commonly used to establish such relationships and also help to obtain the forecast. Regression and correlation techniques are means of describing the association between two or more such variables. Regression means dependence and correlation measures the degree of dependence. Using the regression equation, it is possible to estimate the value of a dependent variable, Y, from an independent variable, X. Two types of regressions are possible: a) Simple regression involves only one independent variable which affects the dependent variable. For example, the gold price is influenced by, say, rising income. b) Multiple regressions involve two or more independent variables influencing the dependent variable. For example, the real estate price is influenced by rising income, shortage of land, and urban migration. Regression is also categorised as linear and nonlinear regression based on the severity of relationship and characteristics. The following table 4.7 shows the examples.

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Simple Linear Non-linear Y= a +b x Y= a+bx2

Multiple Y=a+bx1+cx2+dx3 Y=A+BX1+CX22+DX33

It is to be remembered that known variable = Independent variable and unknown variable = Dependent variable. The forecasting procedures using regression involves the following steps: 1. The variables are plotted along Cartesian or rectangular coordinates 2. A trend equation is developed 3. The equation is used for forecasting 4. The variables are not necessarily related on a time basis The most popular form of the simple linear regression equation is Y = a+bX, where Y= Dependent variable X= Independent variable a = Y intercept b = Slope For a unit change in the value of X, a change in the value of Y occurs in a straight line manner and hence, it is easy to predict the values. To find the values of constants a and b, the following equations are used: y = na + bx xy = a x +bx2 Solving the above two equations, the values of a and b are obtained and then substituted into the regression equation along with the value of X and the value of Y is determined. Example: A departmental store has collected data about sales figures and profits during the last 12 months. Obtain a regression line for the data and predict the profit when sale is 10 Rs. lakh.

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Table 4.8: Data on sales

Sales X (Rs. Lakh): Profit Y (Rs. thousands) 7 2 6 4 14 15 16 12 14 20 15 7

15

10

13

15

25

27

24

20

27

44

24

17

First plot the data and decide if a linear model is reasonable (i.e. do the points seem to scatter around a straight line?) Next compute the quantities x, y, xy and x2. Let linear regression equation is Y = a+bX, where Y= Dependent variable, profit X= Independent variable, sales a = Y intercept b = Slope The following table is constructed:
Table 4.9: Table Construction for regression X 7 2 6 4 14 15 16 12 14 20 15 7 Total Y 15 10 13 15 25 27 24 20 27 44 34 17 132 XY 105 20 78 60 350 405 384 240 378 880 510 119 271 X 49 4 36 16 196 225 256 144 196 400 225 49 3529
2

Y 225 100 169 225 625 729 576 400 729 1936 1156 289 1796

16.15 8.186 14.558 11.372 27.302 28.895 30.488 24.116 27.302 36.86 28.895 16.15 7159

Solving for a and b, we get a = 5.06 and b = 1.593 Therefore, the regression line is Y = 5.06 + 1.593 x When sales X=10, Y = 5.06 +1.593 X = 20.99 Rs. Thousands
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Self Practice Problem Maxwell Motors has collected the following data on annual spare parts sales and new car registrations:
Table 4.10: Data on annual spare parts

Annual spare parts sales (in million $) New car registrations (in thousands)

1.0 10

1.4 12

1.9 15

2.0 16

1.8 14

2.1 17

2.3 20

Develop the linear regression equation and estimate the spare parts sales when new car registrations are 22,000. Answer: Linear Regression equation: Y = -0.16 + 0.13 X Spare parts sales when new car registrations are 22,000 = 2.7 million $

4.13 Accuracy of Forecasting

Finally, we come to an important question. How accurate are the forecasts obtained by the different methods. Any forecast method results in values that may not exactly match the actual values. Hence, deviations are expected. Higher the deviation, more will be the error. Several measures of error in forecast have been developed to examine the issue of error in forecast. Here, we look at two widely used and popular measure applicable to a wide variety of methods. These two measures are: (1) Mean Absolute Deviation (MAD), and (2) Standard Error of Estimate (SE). 4.13.1 Mean Absolute Deviation (MAD) In short range forecasting, MAD is often used to measure how closely forecast values are matching the actual data. MAD is computed as follows: MAD = Sum of absolute deviations for n periods / number of periods. Here deviation = Difference between the actual value and the forecast value. These deviations are added and divided by the number of time periods to get the MAD.

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4.13.2 Standard Error (SE) of estimate The standard error of estimate measures the variability or scatter of the observed values around the regression line. The formula for calculating SE is given below:

where y = values of the dependent variable yest = Estimated values from the estimating equation that correspond to each Y value. n = number of data points used to fit the regression line. It is important to note that the error values should be as low as possible while making comparison and selection.

4.14 Summary
Let us now summarise the key learnings of this unit: For any business activity to be started, the first step would be to predict the demand and then to develop the plans towards meeting the demand either partially or fully. This process of estimating is called forecasting Forecasting basically helps to overcome the uncertainty about the demand and thus provides a workable solution. Supply chain management refers to all the activities that enable the right product at the right place at the right price. Hence, demand forecasting has to be done with utmost care to help identifying the vendors, pricing choices, and material options. Forecasting is broadly classified as quantitative and qualitative Market survey, Delphi method, historical analysis are some of the qualitative methods of forecasting The quantitative methods are divided into two groups. They are time series analysis and causal methods.

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Several measures of error in forecast have been developed to examine the issue of error in forecast. There are two widely used and popular measure applicable to a wide variety of methods. These two measures are: (1) Mean Absolute Deviation and (2) Standard Error of Estimate.

4.15 Glossary
Survey: A detailed study of a market or geographical area to gather data on demand for a product or service, attitudes, opinions, satisfaction level, etc Questionnaire: A form containing a set of questions submitted to people to gain statistical information

4.16 Terminal Questions

1. 2. 3. 4. What is meant by forecasting? Discuss the role of forecasting in modern business context. List the benefits of forecasting. Distinguish between moving average method and weighted moving average method. What are the advantages and disadvantages of these methods? 5. How do you measure the accuracy of forecast? Describe one measure of error used in forecasting.

4.17 Answers
Self Assessment Questions 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. True True True Uncertainty True Actual demand quantitative, qualitative qualitative time series historical analysis
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Terminal Questions 1. 2. 3. 4. 5. Refer to section 4.2 Refer to section 4.3 and 4.4 Refer to section 4.4.1 Refer to section 4.11 Refer to section 4.13

4.18 Case Study

Plastic Junction The Road Ahead Today, it may not be an overstatement to say that we are living in a plastic world. With metal and wood, which were the most commonly used materials for all types of products for centuries, now being replaced by plastic; we cannot imagine life without plastic. You name the product, it is there: bottles, door, furniture, credit card, containers, auto parts, and the list go on. These growing applications of plastic are very encouraging to the plastic manufacturers world over, and the Indian manufacturers are no exception. Plastic manufacturing in India made a humble beginning in India in 1957 when the commercial production of polystyrene started. This was followed by production of LDPE (Low Density Poly Ethylene) in 1959, PVC (poly Vinyl Chloride) in 1961, HDPE (High Density Poly Ethylene) in 1968, and polypropylene in 1978. Indian plastic manufacturing industry largely consists of small and medium enterprises numbering over 30,000 and in the post-liberalisation era after 1991 saw a spurt in joint ventures, foreign investments, and technology acquisitions. This has created a tremendous capacity even in excess of demand in certain segments. With even big industries starting their units related to plastic products manufacturing, the overall industry growth has been quite encouraging. As stated by Yogesh Shaw, President of All India Plastic Manufacturers Association, plastics is a Rs. 85,000 crore turnover industry in India, employing directly and indirectly 3.5 million people and yielding revenues of Rs. 7300 crore to the government annually. He projects plastic production to increase by 60% to reach 12.75 million tones by 2012. It is also expected that the per capita consumption of plastic will double up from the present
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eight kg in the next five years. In comparison, China is 17 kg, US and Europe well over 80 kg, and the world average 23 kg. The plastic production is boosted by the increase in the availability of raw material which comes from petrochemicals industry because of the capacity additions. A yearly growth of 15% is expected to continue for some more time. The major threat to the Indian plastic industry is from China which exports huge quantity of plastic to many countries including India. With cost of acquisition low, Indian promoters also favour using China plastic. In the recent times, the environment consciousness among the people is pressurising the government and the industries to reduce the consumption of plastic and also not to promote the plastic industry. Some major changes too have been brought in by the ruling governments to curb the use of plastic. Plastic Free Zone is the new sign board people have to watch.
(Source: Bana, S. (2011). Its a plastic world, Business India, August 21, 2011, pp 106-108)

Discussion Questions: 1. Which model of forecasting do you suggest for plastic industry? 2. How do you factor in the Chinese threat and the environmental issues in the growth of the industry? 3. If you are a manager in the plastic manufacturing industry, how do you react to the positive and negative factors to the growth of the industry? Reference: Heizer, J. H. and Render, B. (2008), Operations Management, Flexible Version, Pearson Prentice Hall, 2008. Bana, S. (2011). Its a plastic world, Business India, August 21, 2011, pp 106-108

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