Forecasting Chapter 3 Business Notes | EduRev

Business : Forecasting Chapter 3 Business Notes | EduRev

 Page 1


Confirming Pages
      CHAPTER 
3 
  After completing this chapter you 
should be able to:  
   1  List the elements of a good forecast. 
   2  Outline the steps in the forecasting 
process. 
   3  Evaluate at least three qualitative fore-
casting techniques and the advantages 
and disadvantages of each. 
   4  Compare and contrast qualitative and 
quantitative approaches to forecasting. 
   5  Describe averaging techniques, trend 
and seasonal techniques, and regression 
analysis, and solve typical problems. 
   6  Explain three measures of forecast 
accuracy. 
   7  Compare two ways of evaluating and 
controlling forecasts. 
   8  Assess the major factors and trade-offs 
to consider when choosing a forecasting 
technique.  
  CHAPTER OUTLINE 
 Introduction, 74 
 Features Common to All Forecasts, 75 
 Elements of a Good Forecast, 76 
 Forecasting and the Supply Chain 76 
 Steps in the Forecasting Process, 77 
 Forecast Accuracy, 77
 Summarizing Forecast Accuracy, 78  
 Approaches to Forecasting, 80 
 Qualitative Forecasts 80
 Executive Opinions, 80 
 Salesforce Opinions, 81 
 Consumer Surveys, 81 
 Other Approaches, 81  
 Forecasts Based on Time-Series Data, 82
 Naive Methods, 82 
 Techniques for Averaging, 83 
 Other Forecasting Methods, 89 
 Techniques for Trend, 89 
 Trend-Adjusted Exponential Smoothing, 92 
 Techniques for Seasonality, 93 
 Techniques for Cycles, 98  
 Associative Forecasting Techniques, 98
 Simple Linear Regression, 98 
 Comments on the Use of Linear 
Regression Analysis, 102 
 Nonlinear and Multiple Regression 
Analysis, 103  
 Monitoring the Forecast, 103 
 Choosing a Forecasting Technique, 107 
 Using Forecast Information, 109 
 Computer Software in Forecasting, 109 
 Operations Strategy, 109 
Cases:  M&L Manufacturing, 130 
   Highline Financial Services, 
Ltd., 130  
  
 For ecasting 
   LEARNING OBJECTIVES 
 1 Introduction to  Operations 
Management
 2 Competitiveness,  Strategy, and 
Productivity
 3 Forecasting
 4 Product and Service Design
 5 Strategic Capacity Planning for 
Products and Services
 6 Process Selection and Facility 
Layout
 7 Work Design and Measurement
 8 Location Planning and Analysis
 9 Management of Quality
 10 Quality Control
 11 Aggregate Planning and Master 
Scheduling
 12 MRP and ERP
 13 Inventory Management
 14 JIT and Lean Operations
 15 Supply Chain Management
 16 Scheduling
 17 Project Management
 18 Management of Waiting Lines
 19 Linear Programming
ste25251_ch03_072-131.indd   72 ste25251_ch03_072-131.indd   72 11/19/10   9:14:02 PM 11/19/10   9:14:02 PM
Page 2


Confirming Pages
      CHAPTER 
3 
  After completing this chapter you 
should be able to:  
   1  List the elements of a good forecast. 
   2  Outline the steps in the forecasting 
process. 
   3  Evaluate at least three qualitative fore-
casting techniques and the advantages 
and disadvantages of each. 
   4  Compare and contrast qualitative and 
quantitative approaches to forecasting. 
   5  Describe averaging techniques, trend 
and seasonal techniques, and regression 
analysis, and solve typical problems. 
   6  Explain three measures of forecast 
accuracy. 
   7  Compare two ways of evaluating and 
controlling forecasts. 
   8  Assess the major factors and trade-offs 
to consider when choosing a forecasting 
technique.  
  CHAPTER OUTLINE 
 Introduction, 74 
 Features Common to All Forecasts, 75 
 Elements of a Good Forecast, 76 
 Forecasting and the Supply Chain 76 
 Steps in the Forecasting Process, 77 
 Forecast Accuracy, 77
 Summarizing Forecast Accuracy, 78  
 Approaches to Forecasting, 80 
 Qualitative Forecasts 80
 Executive Opinions, 80 
 Salesforce Opinions, 81 
 Consumer Surveys, 81 
 Other Approaches, 81  
 Forecasts Based on Time-Series Data, 82
 Naive Methods, 82 
 Techniques for Averaging, 83 
 Other Forecasting Methods, 89 
 Techniques for Trend, 89 
 Trend-Adjusted Exponential Smoothing, 92 
 Techniques for Seasonality, 93 
 Techniques for Cycles, 98  
 Associative Forecasting Techniques, 98
 Simple Linear Regression, 98 
 Comments on the Use of Linear 
Regression Analysis, 102 
 Nonlinear and Multiple Regression 
Analysis, 103  
 Monitoring the Forecast, 103 
 Choosing a Forecasting Technique, 107 
 Using Forecast Information, 109 
 Computer Software in Forecasting, 109 
 Operations Strategy, 109 
Cases:  M&L Manufacturing, 130 
   Highline Financial Services, 
Ltd., 130  
  
 For ecasting 
   LEARNING OBJECTIVES 
 1 Introduction to  Operations 
Management
 2 Competitiveness,  Strategy, and 
Productivity
 3 Forecasting
 4 Product and Service Design
 5 Strategic Capacity Planning for 
Products and Services
 6 Process Selection and Facility 
Layout
 7 Work Design and Measurement
 8 Location Planning and Analysis
 9 Management of Quality
 10 Quality Control
 11 Aggregate Planning and Master 
Scheduling
 12 MRP and ERP
 13 Inventory Management
 14 JIT and Lean Operations
 15 Supply Chain Management
 16 Scheduling
 17 Project Management
 18 Management of Waiting Lines
 19 Linear Programming
ste25251_ch03_072-131.indd   72 ste25251_ch03_072-131.indd   72 11/19/10   9:14:02 PM 11/19/10   9:14:02 PM
Confirming Pages
73
 Weather forecasts are one of the many types of forecasts used by some business organizations. Although some businesses 
simply rely on publicly available weather forecasts, others turn to firms that specialize in weather-related forecasts. For 
example, Home Depot, Gap, and JCPenney use such firms to help them take weather factors into account for estimating 
demand. 
 Many new car buyers have a thing or two in common. Once they make the decision to buy a new car, they want it as soon 
as possible. They usually don’t want to order it and then have to wait six weeks or more for delivery. If the car dealer they 
visit doesn’t have the car they want, they’ll look elsewhere. Hence, it is important for a dealer to  anticipate  buyer wants 
and to have those models, with the necessary options, in stock. The dealer who can correctly forecast buyer wants, and 
have those cars available, is going to be much more successful than a competitor who guesses instead of forecasting—and 
guesses wrong—and gets stuck with cars customers don’t want. So how does the dealer know how many cars of each type 
to stock? The answer is, the dealer  doesn’t  know for sure, but by analyzing previous buying patterns, and perhaps making 
allowances for current conditions, the dealer can come up with a reasonable  approximation  of what buyers will want. 
 Planning is an integral part of a manager’ s job. If uncertainties cloud the planning horizon, managers will find it difficult 
to plan effectively. Forecasts help managers by reducing some of the uncertainty, thereby enabling them to develop more 
meaningful plans. A    forecast    is a statement about the future value of a variable such as demand. That is, forecasts are pre-
dictions about the future. The better those predictions, the more informed decisions can be. Some forecasts are long range, 
covering several years or more. Long-range forecasts are especially important for decisions that will have long-term conse-
quences for an organization or for a town, city, country, state, or nation. One example is deciding on the right capacity for a 
planned power plant that will operate for the next 20 years. Other forecasts are used to determine if there is a profit potential 
for a new service or a new product: Will there be sufficient demand to make the innovation worthwhile? Many forecasts are 
short term, covering a day or week. They are especially helpful in planning and scheduling day-to-day operations. This chap-
ter provides a survey of business forecasting. It describes the elements of good forecasts, the necessary steps in preparing a 
forecast, basic forecasting techniques, and how to monitor a forecast.
ste25251_ch03_072-131.indd   73 ste25251_ch03_072-131.indd   73 11/19/10   9:14:04 PM 11/19/10   9:14:04 PM
Page 3


Confirming Pages
      CHAPTER 
3 
  After completing this chapter you 
should be able to:  
   1  List the elements of a good forecast. 
   2  Outline the steps in the forecasting 
process. 
   3  Evaluate at least three qualitative fore-
casting techniques and the advantages 
and disadvantages of each. 
   4  Compare and contrast qualitative and 
quantitative approaches to forecasting. 
   5  Describe averaging techniques, trend 
and seasonal techniques, and regression 
analysis, and solve typical problems. 
   6  Explain three measures of forecast 
accuracy. 
   7  Compare two ways of evaluating and 
controlling forecasts. 
   8  Assess the major factors and trade-offs 
to consider when choosing a forecasting 
technique.  
  CHAPTER OUTLINE 
 Introduction, 74 
 Features Common to All Forecasts, 75 
 Elements of a Good Forecast, 76 
 Forecasting and the Supply Chain 76 
 Steps in the Forecasting Process, 77 
 Forecast Accuracy, 77
 Summarizing Forecast Accuracy, 78  
 Approaches to Forecasting, 80 
 Qualitative Forecasts 80
 Executive Opinions, 80 
 Salesforce Opinions, 81 
 Consumer Surveys, 81 
 Other Approaches, 81  
 Forecasts Based on Time-Series Data, 82
 Naive Methods, 82 
 Techniques for Averaging, 83 
 Other Forecasting Methods, 89 
 Techniques for Trend, 89 
 Trend-Adjusted Exponential Smoothing, 92 
 Techniques for Seasonality, 93 
 Techniques for Cycles, 98  
 Associative Forecasting Techniques, 98
 Simple Linear Regression, 98 
 Comments on the Use of Linear 
Regression Analysis, 102 
 Nonlinear and Multiple Regression 
Analysis, 103  
 Monitoring the Forecast, 103 
 Choosing a Forecasting Technique, 107 
 Using Forecast Information, 109 
 Computer Software in Forecasting, 109 
 Operations Strategy, 109 
Cases:  M&L Manufacturing, 130 
   Highline Financial Services, 
Ltd., 130  
  
 For ecasting 
   LEARNING OBJECTIVES 
 1 Introduction to  Operations 
Management
 2 Competitiveness,  Strategy, and 
Productivity
 3 Forecasting
 4 Product and Service Design
 5 Strategic Capacity Planning for 
Products and Services
 6 Process Selection and Facility 
Layout
 7 Work Design and Measurement
 8 Location Planning and Analysis
 9 Management of Quality
 10 Quality Control
 11 Aggregate Planning and Master 
Scheduling
 12 MRP and ERP
 13 Inventory Management
 14 JIT and Lean Operations
 15 Supply Chain Management
 16 Scheduling
 17 Project Management
 18 Management of Waiting Lines
 19 Linear Programming
ste25251_ch03_072-131.indd   72 ste25251_ch03_072-131.indd   72 11/19/10   9:14:02 PM 11/19/10   9:14:02 PM
Confirming Pages
73
 Weather forecasts are one of the many types of forecasts used by some business organizations. Although some businesses 
simply rely on publicly available weather forecasts, others turn to firms that specialize in weather-related forecasts. For 
example, Home Depot, Gap, and JCPenney use such firms to help them take weather factors into account for estimating 
demand. 
 Many new car buyers have a thing or two in common. Once they make the decision to buy a new car, they want it as soon 
as possible. They usually don’t want to order it and then have to wait six weeks or more for delivery. If the car dealer they 
visit doesn’t have the car they want, they’ll look elsewhere. Hence, it is important for a dealer to  anticipate  buyer wants 
and to have those models, with the necessary options, in stock. The dealer who can correctly forecast buyer wants, and 
have those cars available, is going to be much more successful than a competitor who guesses instead of forecasting—and 
guesses wrong—and gets stuck with cars customers don’t want. So how does the dealer know how many cars of each type 
to stock? The answer is, the dealer  doesn’t  know for sure, but by analyzing previous buying patterns, and perhaps making 
allowances for current conditions, the dealer can come up with a reasonable  approximation  of what buyers will want. 
 Planning is an integral part of a manager’ s job. If uncertainties cloud the planning horizon, managers will find it difficult 
to plan effectively. Forecasts help managers by reducing some of the uncertainty, thereby enabling them to develop more 
meaningful plans. A    forecast    is a statement about the future value of a variable such as demand. That is, forecasts are pre-
dictions about the future. The better those predictions, the more informed decisions can be. Some forecasts are long range, 
covering several years or more. Long-range forecasts are especially important for decisions that will have long-term conse-
quences for an organization or for a town, city, country, state, or nation. One example is deciding on the right capacity for a 
planned power plant that will operate for the next 20 years. Other forecasts are used to determine if there is a profit potential 
for a new service or a new product: Will there be sufficient demand to make the innovation worthwhile? Many forecasts are 
short term, covering a day or week. They are especially helpful in planning and scheduling day-to-day operations. This chap-
ter provides a survey of business forecasting. It describes the elements of good forecasts, the necessary steps in preparing a 
forecast, basic forecasting techniques, and how to monitor a forecast.
ste25251_ch03_072-131.indd   73 ste25251_ch03_072-131.indd   73 11/19/10   9:14:04 PM 11/19/10   9:14:04 PM
Confirming Pages
74 Chapter Three Forecasting
     INTRODUCTION  
 F or ecasts are a basic input in the decision processes of operations management because they 
provide information on future demand. The importance of forecasting to operations manage-
ment cannot be overstated. The primary goal of operations management is to match supply to 
demand. Having a forecast of demand is essential for determining how much capacity or supply 
will be needed to meet demand. For instance, operations needs to know what capacity will be 
needed to make staffing and equipment decisions, budgets must be prepared, purchasing needs 
information for ordering from suppliers, and supply chain partners need to make their plans.   
 Two aspects of forecasts are important. One is the expected level of demand; the other is 
the degree of accuracy that can be assigned to a forecast (i.e., the potential size of forecast 
error). The expected level of demand can be a function of some structural variation, such as a 
trend or seasonal variation. Forecast accuracy is a function of the ability of forecasters to cor-
rectly model demand, random variation, and sometimes unforeseen events. 
 Forecasts are made with reference to a specific time horizon. The time horizon may be fairly 
short (e.g., an hour, day, week, or month), or somewhat longer (e.g., the next six months, the 
next year, the next five years, or the life of a product or service). Short-term forecasts pertain 
to ongoing operations. Long-range forecasts can be an important strategic planning tool. Long-
term forecasts pertain to new products or services, new equipment, new facilities, or something 
else that will require a somewhat long lead time to develop, construct, or otherwise implement. 
 Forecasts are the basis for budgeting, planning capacity, sales, production and inventory, 
personnel, purchasing, and more. Forecasts play an important role in the planning process 
because they enable managers to anticipate the future so they can plan accordingly. 
 Forecasts affect decisions and activities throughout an organization, in accounting, finance, 
human resources, marketing, and management information systems (MIS), as well as in oper-
ations and other parts of an organization. Here are some examples of uses of forecasts in 
business organizations:
    Accounting.  New product/process cost estimates, profit projections, cash management.  
   Finance.  Equipment/equipment replacement needs, timing and amount of funding/ 
borrowing needs.  
     F or ecast    A statement about 
the future value of a variable of 
interest.    
     F or ecast    A statement about 
the future value of a variable of 
interest.    
The W alt Disney W orld forecasting 
department has 20 employees 
who formulate forecasts on 
volume and revenue for the 
theme parks, water parks, resort 
hotels, as well as merchandise, 
food, and beverage revenue by 
location.
ste25251_ch03_072-131.indd   74 ste25251_ch03_072-131.indd   74 11/19/10   9:14:19 PM 11/19/10   9:14:19 PM
Page 4


Confirming Pages
      CHAPTER 
3 
  After completing this chapter you 
should be able to:  
   1  List the elements of a good forecast. 
   2  Outline the steps in the forecasting 
process. 
   3  Evaluate at least three qualitative fore-
casting techniques and the advantages 
and disadvantages of each. 
   4  Compare and contrast qualitative and 
quantitative approaches to forecasting. 
   5  Describe averaging techniques, trend 
and seasonal techniques, and regression 
analysis, and solve typical problems. 
   6  Explain three measures of forecast 
accuracy. 
   7  Compare two ways of evaluating and 
controlling forecasts. 
   8  Assess the major factors and trade-offs 
to consider when choosing a forecasting 
technique.  
  CHAPTER OUTLINE 
 Introduction, 74 
 Features Common to All Forecasts, 75 
 Elements of a Good Forecast, 76 
 Forecasting and the Supply Chain 76 
 Steps in the Forecasting Process, 77 
 Forecast Accuracy, 77
 Summarizing Forecast Accuracy, 78  
 Approaches to Forecasting, 80 
 Qualitative Forecasts 80
 Executive Opinions, 80 
 Salesforce Opinions, 81 
 Consumer Surveys, 81 
 Other Approaches, 81  
 Forecasts Based on Time-Series Data, 82
 Naive Methods, 82 
 Techniques for Averaging, 83 
 Other Forecasting Methods, 89 
 Techniques for Trend, 89 
 Trend-Adjusted Exponential Smoothing, 92 
 Techniques for Seasonality, 93 
 Techniques for Cycles, 98  
 Associative Forecasting Techniques, 98
 Simple Linear Regression, 98 
 Comments on the Use of Linear 
Regression Analysis, 102 
 Nonlinear and Multiple Regression 
Analysis, 103  
 Monitoring the Forecast, 103 
 Choosing a Forecasting Technique, 107 
 Using Forecast Information, 109 
 Computer Software in Forecasting, 109 
 Operations Strategy, 109 
Cases:  M&L Manufacturing, 130 
   Highline Financial Services, 
Ltd., 130  
  
 For ecasting 
   LEARNING OBJECTIVES 
 1 Introduction to  Operations 
Management
 2 Competitiveness,  Strategy, and 
Productivity
 3 Forecasting
 4 Product and Service Design
 5 Strategic Capacity Planning for 
Products and Services
 6 Process Selection and Facility 
Layout
 7 Work Design and Measurement
 8 Location Planning and Analysis
 9 Management of Quality
 10 Quality Control
 11 Aggregate Planning and Master 
Scheduling
 12 MRP and ERP
 13 Inventory Management
 14 JIT and Lean Operations
 15 Supply Chain Management
 16 Scheduling
 17 Project Management
 18 Management of Waiting Lines
 19 Linear Programming
ste25251_ch03_072-131.indd   72 ste25251_ch03_072-131.indd   72 11/19/10   9:14:02 PM 11/19/10   9:14:02 PM
Confirming Pages
73
 Weather forecasts are one of the many types of forecasts used by some business organizations. Although some businesses 
simply rely on publicly available weather forecasts, others turn to firms that specialize in weather-related forecasts. For 
example, Home Depot, Gap, and JCPenney use such firms to help them take weather factors into account for estimating 
demand. 
 Many new car buyers have a thing or two in common. Once they make the decision to buy a new car, they want it as soon 
as possible. They usually don’t want to order it and then have to wait six weeks or more for delivery. If the car dealer they 
visit doesn’t have the car they want, they’ll look elsewhere. Hence, it is important for a dealer to  anticipate  buyer wants 
and to have those models, with the necessary options, in stock. The dealer who can correctly forecast buyer wants, and 
have those cars available, is going to be much more successful than a competitor who guesses instead of forecasting—and 
guesses wrong—and gets stuck with cars customers don’t want. So how does the dealer know how many cars of each type 
to stock? The answer is, the dealer  doesn’t  know for sure, but by analyzing previous buying patterns, and perhaps making 
allowances for current conditions, the dealer can come up with a reasonable  approximation  of what buyers will want. 
 Planning is an integral part of a manager’ s job. If uncertainties cloud the planning horizon, managers will find it difficult 
to plan effectively. Forecasts help managers by reducing some of the uncertainty, thereby enabling them to develop more 
meaningful plans. A    forecast    is a statement about the future value of a variable such as demand. That is, forecasts are pre-
dictions about the future. The better those predictions, the more informed decisions can be. Some forecasts are long range, 
covering several years or more. Long-range forecasts are especially important for decisions that will have long-term conse-
quences for an organization or for a town, city, country, state, or nation. One example is deciding on the right capacity for a 
planned power plant that will operate for the next 20 years. Other forecasts are used to determine if there is a profit potential 
for a new service or a new product: Will there be sufficient demand to make the innovation worthwhile? Many forecasts are 
short term, covering a day or week. They are especially helpful in planning and scheduling day-to-day operations. This chap-
ter provides a survey of business forecasting. It describes the elements of good forecasts, the necessary steps in preparing a 
forecast, basic forecasting techniques, and how to monitor a forecast.
ste25251_ch03_072-131.indd   73 ste25251_ch03_072-131.indd   73 11/19/10   9:14:04 PM 11/19/10   9:14:04 PM
Confirming Pages
74 Chapter Three Forecasting
     INTRODUCTION  
 F or ecasts are a basic input in the decision processes of operations management because they 
provide information on future demand. The importance of forecasting to operations manage-
ment cannot be overstated. The primary goal of operations management is to match supply to 
demand. Having a forecast of demand is essential for determining how much capacity or supply 
will be needed to meet demand. For instance, operations needs to know what capacity will be 
needed to make staffing and equipment decisions, budgets must be prepared, purchasing needs 
information for ordering from suppliers, and supply chain partners need to make their plans.   
 Two aspects of forecasts are important. One is the expected level of demand; the other is 
the degree of accuracy that can be assigned to a forecast (i.e., the potential size of forecast 
error). The expected level of demand can be a function of some structural variation, such as a 
trend or seasonal variation. Forecast accuracy is a function of the ability of forecasters to cor-
rectly model demand, random variation, and sometimes unforeseen events. 
 Forecasts are made with reference to a specific time horizon. The time horizon may be fairly 
short (e.g., an hour, day, week, or month), or somewhat longer (e.g., the next six months, the 
next year, the next five years, or the life of a product or service). Short-term forecasts pertain 
to ongoing operations. Long-range forecasts can be an important strategic planning tool. Long-
term forecasts pertain to new products or services, new equipment, new facilities, or something 
else that will require a somewhat long lead time to develop, construct, or otherwise implement. 
 Forecasts are the basis for budgeting, planning capacity, sales, production and inventory, 
personnel, purchasing, and more. Forecasts play an important role in the planning process 
because they enable managers to anticipate the future so they can plan accordingly. 
 Forecasts affect decisions and activities throughout an organization, in accounting, finance, 
human resources, marketing, and management information systems (MIS), as well as in oper-
ations and other parts of an organization. Here are some examples of uses of forecasts in 
business organizations:
    Accounting.  New product/process cost estimates, profit projections, cash management.  
   Finance.  Equipment/equipment replacement needs, timing and amount of funding/ 
borrowing needs.  
     F or ecast    A statement about 
the future value of a variable of 
interest.    
     F or ecast    A statement about 
the future value of a variable of 
interest.    
The W alt Disney W orld forecasting 
department has 20 employees 
who formulate forecasts on 
volume and revenue for the 
theme parks, water parks, resort 
hotels, as well as merchandise, 
food, and beverage revenue by 
location.
ste25251_ch03_072-131.indd   74 ste25251_ch03_072-131.indd   74 11/19/10   9:14:19 PM 11/19/10   9:14:19 PM
Confirming Pages
 Chapter Three Forecasting 75
   Human resources.  Hiring activities, including recruitment, interviewing, and training; 
layoff planning, including outplacement counseling.  
   Marketing.  Pricing and promotion, e-business strategies, global competition strategies.  
   MIS.  New/revised information systems, Internet services.  
   Operations.  Schedules, capacity planning, work assignments and workloads, inventory 
planning, make-or-buy decisions, outsourcing, project management.  
   Product/service design.  Revision of current features, design of new products or services.    
 In most of these uses of forecasts, decisions in one area have consequences in other areas. 
Therefore, it is very important for all affected areas to agree on a common forecast. However, 
this may not be easy to accomplish. Different departments often have very different perspec-
tives on a forecast, making a consensus forecast difficult to achieve. For example, salespeople, 
by their very nature, may be overly optimistic with their forecasts, and may want to “reserve” 
capacity for their customers. This can result in excess costs for operations and inventory stor-
age. Conversely, if demand exceeds forecasts, operations and the supply chain may not be able 
to meet demand, which would mean lost business and dissatisfied customers. 
 Forecasting is also an important component of  yield management,  which relates to the 
percentage of capacity being used. Accurate forecasts can help managers plan tactics (e.g., 
offer discounts, don’t offer discounts) to match capacity with demand, thereby achieving high 
yield levels. 
 There are two uses for forecasts. One is to help managers  plan the system,  and the other 
is to help them  plan the use of the system.  Planning the system generally involves long-range 
plans about the types of products and services to offer, what facilities and equipment to have, 
where to locate, and so on. Planning the use of the system refers to short-range and interme-
diate-range planning, which involve tasks such as planning inventory and workforce levels, 
planning purchasing and production, budgeting, and scheduling. 
 Business forecasting pertains to more than predicting demand. Forecasts are also used to 
predict profits, revenues, costs, productivity changes, prices and availability of energy and 
raw materials, interest rates, movements of key economic indicators (e.g., gross domestic 
product, inflation, government borrowing), and prices of stocks and bonds. For the sake of 
simplicity, this chapter will focus on the forecasting of demand. Keep in mind, however, that 
the concepts and techniques apply equally well to the other variables. 
 In spite of its use of computers and sophisticated mathematical models, forecasting is not 
an exact science. Instead, successful forecasting often requires a skillful blending of science 
and intuition. Experience, judgment, and technical expertise all play a role in developing use-
ful forecasts. Along with these, a certain amount of luck and a dash of humility can be helpful, 
because the worst forecasters occasionally produce a very good forecast, and even the best 
forecasters sometimes miss completely. Current forecasting techniques range from the mun-
dane to the exotic. Some work better than others, but no single technique works all the time.   
  FEATURES COMMON TO ALL FORECASTS  
 A wide variety of forecasting techniques are in use. In many respects, they are quite different 
from each other, as you shall soon discover. Nonetheless, certain features are common to all, 
and it is important to recognize them.
    1. Forecasting techniques generally assume that the same underlying causal system that 
e xisted in the past will continue to e xist in the future.            
  Comment   A manager cannot simply delegate forecasting to models or computers and then 
forget about it, because unplanned occurrences can wreak havoc with forecasts. For instance, 
weather-related events, tax increases or decreases, and changes in features or prices of competing 
products or services can have a major impact on demand. Consequently, a manager must be alert 
to such occurrences and be ready to override forecasts, which assume a stable causal system.
ste25251_ch03_072-131.indd   75 ste25251_ch03_072-131.indd   75 11/19/10   9:14:27 PM 11/19/10   9:14:27 PM
Page 5


Confirming Pages
      CHAPTER 
3 
  After completing this chapter you 
should be able to:  
   1  List the elements of a good forecast. 
   2  Outline the steps in the forecasting 
process. 
   3  Evaluate at least three qualitative fore-
casting techniques and the advantages 
and disadvantages of each. 
   4  Compare and contrast qualitative and 
quantitative approaches to forecasting. 
   5  Describe averaging techniques, trend 
and seasonal techniques, and regression 
analysis, and solve typical problems. 
   6  Explain three measures of forecast 
accuracy. 
   7  Compare two ways of evaluating and 
controlling forecasts. 
   8  Assess the major factors and trade-offs 
to consider when choosing a forecasting 
technique.  
  CHAPTER OUTLINE 
 Introduction, 74 
 Features Common to All Forecasts, 75 
 Elements of a Good Forecast, 76 
 Forecasting and the Supply Chain 76 
 Steps in the Forecasting Process, 77 
 Forecast Accuracy, 77
 Summarizing Forecast Accuracy, 78  
 Approaches to Forecasting, 80 
 Qualitative Forecasts 80
 Executive Opinions, 80 
 Salesforce Opinions, 81 
 Consumer Surveys, 81 
 Other Approaches, 81  
 Forecasts Based on Time-Series Data, 82
 Naive Methods, 82 
 Techniques for Averaging, 83 
 Other Forecasting Methods, 89 
 Techniques for Trend, 89 
 Trend-Adjusted Exponential Smoothing, 92 
 Techniques for Seasonality, 93 
 Techniques for Cycles, 98  
 Associative Forecasting Techniques, 98
 Simple Linear Regression, 98 
 Comments on the Use of Linear 
Regression Analysis, 102 
 Nonlinear and Multiple Regression 
Analysis, 103  
 Monitoring the Forecast, 103 
 Choosing a Forecasting Technique, 107 
 Using Forecast Information, 109 
 Computer Software in Forecasting, 109 
 Operations Strategy, 109 
Cases:  M&L Manufacturing, 130 
   Highline Financial Services, 
Ltd., 130  
  
 For ecasting 
   LEARNING OBJECTIVES 
 1 Introduction to  Operations 
Management
 2 Competitiveness,  Strategy, and 
Productivity
 3 Forecasting
 4 Product and Service Design
 5 Strategic Capacity Planning for 
Products and Services
 6 Process Selection and Facility 
Layout
 7 Work Design and Measurement
 8 Location Planning and Analysis
 9 Management of Quality
 10 Quality Control
 11 Aggregate Planning and Master 
Scheduling
 12 MRP and ERP
 13 Inventory Management
 14 JIT and Lean Operations
 15 Supply Chain Management
 16 Scheduling
 17 Project Management
 18 Management of Waiting Lines
 19 Linear Programming
ste25251_ch03_072-131.indd   72 ste25251_ch03_072-131.indd   72 11/19/10   9:14:02 PM 11/19/10   9:14:02 PM
Confirming Pages
73
 Weather forecasts are one of the many types of forecasts used by some business organizations. Although some businesses 
simply rely on publicly available weather forecasts, others turn to firms that specialize in weather-related forecasts. For 
example, Home Depot, Gap, and JCPenney use such firms to help them take weather factors into account for estimating 
demand. 
 Many new car buyers have a thing or two in common. Once they make the decision to buy a new car, they want it as soon 
as possible. They usually don’t want to order it and then have to wait six weeks or more for delivery. If the car dealer they 
visit doesn’t have the car they want, they’ll look elsewhere. Hence, it is important for a dealer to  anticipate  buyer wants 
and to have those models, with the necessary options, in stock. The dealer who can correctly forecast buyer wants, and 
have those cars available, is going to be much more successful than a competitor who guesses instead of forecasting—and 
guesses wrong—and gets stuck with cars customers don’t want. So how does the dealer know how many cars of each type 
to stock? The answer is, the dealer  doesn’t  know for sure, but by analyzing previous buying patterns, and perhaps making 
allowances for current conditions, the dealer can come up with a reasonable  approximation  of what buyers will want. 
 Planning is an integral part of a manager’ s job. If uncertainties cloud the planning horizon, managers will find it difficult 
to plan effectively. Forecasts help managers by reducing some of the uncertainty, thereby enabling them to develop more 
meaningful plans. A    forecast    is a statement about the future value of a variable such as demand. That is, forecasts are pre-
dictions about the future. The better those predictions, the more informed decisions can be. Some forecasts are long range, 
covering several years or more. Long-range forecasts are especially important for decisions that will have long-term conse-
quences for an organization or for a town, city, country, state, or nation. One example is deciding on the right capacity for a 
planned power plant that will operate for the next 20 years. Other forecasts are used to determine if there is a profit potential 
for a new service or a new product: Will there be sufficient demand to make the innovation worthwhile? Many forecasts are 
short term, covering a day or week. They are especially helpful in planning and scheduling day-to-day operations. This chap-
ter provides a survey of business forecasting. It describes the elements of good forecasts, the necessary steps in preparing a 
forecast, basic forecasting techniques, and how to monitor a forecast.
ste25251_ch03_072-131.indd   73 ste25251_ch03_072-131.indd   73 11/19/10   9:14:04 PM 11/19/10   9:14:04 PM
Confirming Pages
74 Chapter Three Forecasting
     INTRODUCTION  
 F or ecasts are a basic input in the decision processes of operations management because they 
provide information on future demand. The importance of forecasting to operations manage-
ment cannot be overstated. The primary goal of operations management is to match supply to 
demand. Having a forecast of demand is essential for determining how much capacity or supply 
will be needed to meet demand. For instance, operations needs to know what capacity will be 
needed to make staffing and equipment decisions, budgets must be prepared, purchasing needs 
information for ordering from suppliers, and supply chain partners need to make their plans.   
 Two aspects of forecasts are important. One is the expected level of demand; the other is 
the degree of accuracy that can be assigned to a forecast (i.e., the potential size of forecast 
error). The expected level of demand can be a function of some structural variation, such as a 
trend or seasonal variation. Forecast accuracy is a function of the ability of forecasters to cor-
rectly model demand, random variation, and sometimes unforeseen events. 
 Forecasts are made with reference to a specific time horizon. The time horizon may be fairly 
short (e.g., an hour, day, week, or month), or somewhat longer (e.g., the next six months, the 
next year, the next five years, or the life of a product or service). Short-term forecasts pertain 
to ongoing operations. Long-range forecasts can be an important strategic planning tool. Long-
term forecasts pertain to new products or services, new equipment, new facilities, or something 
else that will require a somewhat long lead time to develop, construct, or otherwise implement. 
 Forecasts are the basis for budgeting, planning capacity, sales, production and inventory, 
personnel, purchasing, and more. Forecasts play an important role in the planning process 
because they enable managers to anticipate the future so they can plan accordingly. 
 Forecasts affect decisions and activities throughout an organization, in accounting, finance, 
human resources, marketing, and management information systems (MIS), as well as in oper-
ations and other parts of an organization. Here are some examples of uses of forecasts in 
business organizations:
    Accounting.  New product/process cost estimates, profit projections, cash management.  
   Finance.  Equipment/equipment replacement needs, timing and amount of funding/ 
borrowing needs.  
     F or ecast    A statement about 
the future value of a variable of 
interest.    
     F or ecast    A statement about 
the future value of a variable of 
interest.    
The W alt Disney W orld forecasting 
department has 20 employees 
who formulate forecasts on 
volume and revenue for the 
theme parks, water parks, resort 
hotels, as well as merchandise, 
food, and beverage revenue by 
location.
ste25251_ch03_072-131.indd   74 ste25251_ch03_072-131.indd   74 11/19/10   9:14:19 PM 11/19/10   9:14:19 PM
Confirming Pages
 Chapter Three Forecasting 75
   Human resources.  Hiring activities, including recruitment, interviewing, and training; 
layoff planning, including outplacement counseling.  
   Marketing.  Pricing and promotion, e-business strategies, global competition strategies.  
   MIS.  New/revised information systems, Internet services.  
   Operations.  Schedules, capacity planning, work assignments and workloads, inventory 
planning, make-or-buy decisions, outsourcing, project management.  
   Product/service design.  Revision of current features, design of new products or services.    
 In most of these uses of forecasts, decisions in one area have consequences in other areas. 
Therefore, it is very important for all affected areas to agree on a common forecast. However, 
this may not be easy to accomplish. Different departments often have very different perspec-
tives on a forecast, making a consensus forecast difficult to achieve. For example, salespeople, 
by their very nature, may be overly optimistic with their forecasts, and may want to “reserve” 
capacity for their customers. This can result in excess costs for operations and inventory stor-
age. Conversely, if demand exceeds forecasts, operations and the supply chain may not be able 
to meet demand, which would mean lost business and dissatisfied customers. 
 Forecasting is also an important component of  yield management,  which relates to the 
percentage of capacity being used. Accurate forecasts can help managers plan tactics (e.g., 
offer discounts, don’t offer discounts) to match capacity with demand, thereby achieving high 
yield levels. 
 There are two uses for forecasts. One is to help managers  plan the system,  and the other 
is to help them  plan the use of the system.  Planning the system generally involves long-range 
plans about the types of products and services to offer, what facilities and equipment to have, 
where to locate, and so on. Planning the use of the system refers to short-range and interme-
diate-range planning, which involve tasks such as planning inventory and workforce levels, 
planning purchasing and production, budgeting, and scheduling. 
 Business forecasting pertains to more than predicting demand. Forecasts are also used to 
predict profits, revenues, costs, productivity changes, prices and availability of energy and 
raw materials, interest rates, movements of key economic indicators (e.g., gross domestic 
product, inflation, government borrowing), and prices of stocks and bonds. For the sake of 
simplicity, this chapter will focus on the forecasting of demand. Keep in mind, however, that 
the concepts and techniques apply equally well to the other variables. 
 In spite of its use of computers and sophisticated mathematical models, forecasting is not 
an exact science. Instead, successful forecasting often requires a skillful blending of science 
and intuition. Experience, judgment, and technical expertise all play a role in developing use-
ful forecasts. Along with these, a certain amount of luck and a dash of humility can be helpful, 
because the worst forecasters occasionally produce a very good forecast, and even the best 
forecasters sometimes miss completely. Current forecasting techniques range from the mun-
dane to the exotic. Some work better than others, but no single technique works all the time.   
  FEATURES COMMON TO ALL FORECASTS  
 A wide variety of forecasting techniques are in use. In many respects, they are quite different 
from each other, as you shall soon discover. Nonetheless, certain features are common to all, 
and it is important to recognize them.
    1. Forecasting techniques generally assume that the same underlying causal system that 
e xisted in the past will continue to e xist in the future.            
  Comment   A manager cannot simply delegate forecasting to models or computers and then 
forget about it, because unplanned occurrences can wreak havoc with forecasts. For instance, 
weather-related events, tax increases or decreases, and changes in features or prices of competing 
products or services can have a major impact on demand. Consequently, a manager must be alert 
to such occurrences and be ready to override forecasts, which assume a stable causal system.
ste25251_ch03_072-131.indd   75 ste25251_ch03_072-131.indd   75 11/19/10   9:14:27 PM 11/19/10   9:14:27 PM
Confirming Pages
76 Chapter Three Forecasting
    2. Forecasts are not perfect; actual results usually differ from predicted values; the pres-
ence of randomness precludes a perfect forecast. Allowances should be made for forecast 
er rors.  
   3. Forecasts for groups of items tend to be more accurate than forecasts for individual items 
because forecasting errors among items in a group usually have a canceling effect. Oppor-
tunities for grouping may arise if parts or raw materials are used for multiple products or 
if a product or service is demanded by a number of independent sources.  
   4. Forecast accuracy decreases as the time period covered by the forecast—the  time hori-
zon —increases. Generally speaking, short-range forecasts must contend with fewer 
uncertainties than longer-range forecasts, so they tend to be more accurate.    
 An important consequence of the last point is that flexible business organizations—those 
that can respond quickly to changes in demand—require a shorter forecasting horizon and, 
hence, benefit from more accurate short-range forecasts than competitors who are less flex-
ible and who must therefore use longer forecast horizons.      
  ELEMENTS OF A GOOD FORECAST  
 A properly prepared forecast should fulfill certain requirements:
    1. The forecast should be  timely.  Usually, a certain amount of time is needed to respond to 
the information contained in a forecast. For example, capacity cannot be expanded over-
night, nor can inventory levels be changed immediately. Hence, the forecasting horizon 
must cover the time necessary to implement possible changes.  
   2. The forecast should be  accurate,  and the degree of accuracy should be stated. This will 
enable users to plan for possible errors and will provide a basis for comparing alternative 
forecasts.  
   3. The forecast should be  reliable;  it should work consistently. A technique that sometimes 
provides a good forecast and sometimes a poor one will leave users with the uneasy feel-
ing that they may get burned every time a new forecast is issued.  
   4. The forecast should be expressed in  meaningful units.  Financial planners need to know 
how many  dollars  will be needed, production planners need to know how many  units  will 
be needed, and schedulers need to know what  machines  and  skills  will be required. The 
choice of units depends on user needs.  
   5. The forecast should be  in writing.  Although this will not guarantee that all concerned 
are using the same information, it will at least increase the likelihood of it. In addition, 
a written forecast will permit an objective basis for evaluating the forecast once actual 
results are in.  
   6. The forecasting technique should be  simple to understand and use.  Users often lack 
confidence in forecasts based on sophisticated techniques; they do not understand either 
the circumstances in which the techniques are appropriate or the limitations of the tech-
niques. Misuse of techniques is an obvious consequence. Not surprisingly, fairly simple 
forecasting techniques enjoy widespread popularity because users are more comfortable 
working with them.  
   7. The forecast should be  cost-effective:  The benefits should outweigh the costs.      
    FORECASTING AND THE SUPPLY CHAIN  
 Accurate forecasts are very important for the supply chain. Inaccurate forecasts can lead to 
shortages and excesses throughout the supply chain. Shortages of materials, parts, and services 
can lead to missed deliveries, work disruption, and poor customer service. Conversely, overly 
optimistic forecasts can lead to excesses of materials and/or capacity, which increase costs. 
Both shortages and excesses in the supply chain have a negative impact not only on customer 
ste25251_ch03_072-131.indd   76 ste25251_ch03_072-131.indd   76 11/19/10   9:14:27 PM 11/19/10   9:14:27 PM
Read More
Offer running on EduRev: Apply code STAYHOME200 to get INR 200 off on our premium plan EduRev Infinity!

Related Searches

Objective type Questions

,

Summary

,

Exam

,

practice quizzes

,

Previous Year Questions with Solutions

,

Forecasting Chapter 3 Business Notes | EduRev

,

past year papers

,

study material

,

MCQs

,

Forecasting Chapter 3 Business Notes | EduRev

,

Free

,

pdf

,

ppt

,

Viva Questions

,

mock tests for examination

,

video lectures

,

Semester Notes

,

shortcuts and tricks

,

Sample Paper

,

Forecasting Chapter 3 Business Notes | EduRev

,

Extra Questions

,

Important questions

;