NITIE,

Mumbai
Chap 8 Forecasting

Dipak Ramchandra Sutar

Chapter 8 Forecasting
Introduction

Forecasting is a prelude to planning, an estimate of what conditions will exist over some future
period.

Demand Management

The prime purpose of an organization is to serve the customer. Marketing focuses on meeting
customer needs, but operations, through materials management, must provide the resources. The
coordination of plans by these two parties is demand management. Demand management is the
function of recognizing and managing all demands for products, including forecasting, order
processing, making delivery promises (available-to-promise), and interfacing between manufacturing
planning and control and the marketplace.

Demand Forecasting

Forecasts are made for the strategic business plan, the production plan, and the master production
schedule.

Characteristics of Demand

The difference between demand and sales is that sales implies what is actually sold whereas
demand shows the need for the item. Sometimes demand cannot be satisfied, and sales will be less
than demand.

The pattern shows that actual demand varies from period to period. The four reasons for this are
trend, seasonality, random variation, and cycle.

The shape of demand patterns for some products or services change over time, others do not. Those
that retain the same general shape are called stable and those that do not are called dynamic. The
more stable the demand, the easier it is to forecast.

National Institute of Industrial Engineering |Chap 8 Forecasting

Principles of Forecasting

Forecasts have four major characteristics or principles: (1) Forecasts are usually wrong. Errors are
inevitable and must be expected. (2) Every forecast should include an estimate of error. (3) Forecasts
are more accurate for families or groups. (4) Forecasts are more accurate for nearer time periods.
Anything that can be done to reduce lead-time will improve forecast accuracy.

Forecasting Techniques

Forecasting methods are classified into 3 categories: qualitative, extrinsic, and intrinsic.

Some Important Intrinsic Techniques

Usually methods that average out history are better because they dampen out some effects of random
variation. It is best to forecast the average demand rather than second-guess what the effect of
random fluctuation will be. A forecast of average demand should be made, and the estimate of error
applied to it.

The point is that a moving average always lags a trend, and the more periods included in the average,
the greater the lag will be. On the other hand, if there is no trend but actual demand fluctuates
considerably due to random variation, a moving average based on a few periods reacts to the
fluctuation rather than forecasts the average. Moving averages are best used for forecasting products
with stable demand when there is little trend or seasonality.

A common forecasting technique, called exponential smoothing, gives the same results as a moving
average but without the need to retain as much data and with easier calculations. The forecast can be
based on the prior old calculated forecast and the new data.

The weight given to the latest actual demand is called a smoothing constant and is represented by
the greek letter alpha (). It is always expressed as a decimal from 0 to 1.0. The formula is: New
forecast = ( )(latest demand) + (1- )(previous forecast).

Seasonality

Many products have a seasonal or periodic demand pattern. The seasonal index is an estimate of
how much the demand during the season will be above or below the average demand for the product.
National Institute of Industrial Engineering |Chap 8 Forecasting

Seasonal Index = Period Average Demand / Average Demand for all Periods

The average demand for all periods is a value that averages out seasonality. This is called the
deseasonalized demand.
Seasonal Index = Period Average Demand / Deseasonalized Demand

Tracking the Forecast

Tracking the forecast is the process of comparing actual demand with the forecast. Forecast error is
the difference between actual and forecast demand. Error can occur in two ways: bias and random
variation. Bias exists when the cumulative actual demand varies from the cumulative forecast. Bias
is a systematic error in which the actual demand is consistently above or below the forecast demand.

Forecast error must be measured before it can be used to revise the forecast or to help in planning.
One way to measure the variability is to calculate the total error ignoring the plus and minus signs and
take the average. This is called mean absolute deviation (MAD): mean implies an average, absolute
means without reference to plus and minus, and deviation refers to the error.

MAD = Sum of Absolute Deviations / Number of Observations

Reference

1. Introduction to Material management: Fifth Edition J. R. Tony Arnold, Stephen N.

Chapman, R.V. Ramakrishnan

National Institute of Industrial Engineering |Chap 8 Forecasting