Fundamentals of Operations Management

BUS 3 140

Forecasting
Feb 5, 2008

Forecasting
A statement about the future value of a variable of interest Future Sales Weather Stock Prices Other Short term and Long term estimates Several Methods Quantitative History and Patterns Leading Indicators / Associations (Housing Starts & Furniture) Qualitative Judgment Consensus
Used for making informed Decisions and taking Actions based on those decisions
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Forecasting

Forecasts make a MAJOR IMPACT (Positive or Negative) on: Revenue Market Share Cost Inventory Profit

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Features Common to all Forecasts

Generally assumes that what drove past performance and behavior will drive future performance and behavior Credit Rating Insurance Rates Other

More accurate for groups vs. individuals

Accuracy decreases as time horizon increases

Forecasts WILL be wrong the goal is to predict as closely as possible

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Three Major Types of Forecasts

Judgmental Uses subjective, qualitative judgment (opinions, surveys, experts, managers, others). Most useful when there is limited data and with New Product Introductions Time series Observes what has occurred over previous time periods and assumes that future patterns will follow historical patterns

Associative Models Establishes cause and effect relationships between independent and dependent variables (rainy days and umbrella sales, pricing and sales volume, attendance at sporting events and food sold, others)

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Forecasting techniques (Table 3.6)

Approach Technique Consumer surveys Brief Description Questioning consumers on future plans

Direct-contact composites

Joint estimates obtained from sales or customer service Finance, marketing, and manufacturing managers join to prepare forecast Series of questionnaires answered anonymously by knowledgeable people; successive questionnaires are based on information obtained from previous surveys Consultants or other outside experts prepare the forecast

Judgment / opinion: QUALITATIVE

Executive opinion

Delphi technique

Outside opinion

Time series: Nave

Next value in a series will equal the previous value in a comparable period

Time series: Moving Averages Forecast is based on an average of recent values

Statistical: QUANTITATIVE

Time series: Exponential Smoothing Associative Models: Simple Regression Associative Models: Multiple Regression

Sophisticated form of weighted moving average Values of one variable are used to predict values of a dependent variable Two or more variables are used to predict values of a dependent variable

* From Stevenson, Operations Management, Ninth Edition, McGraw Hill Irwin

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Elements of any Good Forecast

Timely

Reliable

Accurate

Written

* From Stevenson, Operations Management, Ninth Edition, McGraw Hill Irwin

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Steps in the Forecasting Process

Step 6 Monitor the forecast

Step 5 Make the forecast Step 4 Obtain, clean and analyze data Step 3 Select a forecasting technique
Step 2 Establish a time horizon Step 1 Determine purpose of forecast

* From Stevenson, Operations Management, Ninth Edition, McGraw Hill Irwin

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Forecast Factors (Table 3.5)

Factor Frequency Short Range Often Intermediate Range Occasional Long Range Infrequent

Level of Aggregation

Item

Product Family

Total Output, Type of product / service

Type of Model

Smoothing, Projection, Regression

Projection, Seasonal, Regression

Managerial Judgment

Degree of Management Involvement

Low

Moderate

High

Cost per Forecast

Low

Moderate

High

Forecasts are established with two (2) Units of Measure: 1. Units 2. Dollars Both have significance to the Enterprise
* From Stevenson, Operations Management, Ninth Edition, McGraw Hill Irwin
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Start with what you KNOW

How many people will attend the next Giants game?

Tickets already sold Patterns of walk up sales Visiting team Weather School day Other

How many Sewing Machines will Singer sell this week? Orders in Backlog Inventory in Stores Production capacity Household Budget Rent Car Payment Bills Rest of money
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A Demand Forecast serves many Purposes

WHAT is done and WHY?

Region

Product Line

Channel

Features

Product

Customer

Revenue Planning Revenue Scenarios Allocation Criteria Commissions & Quotas

Estimating TAM and Share Pricing Targets Programs & Promotions Margins @ Mixes Message to Analysts

Scheduling Factory Volumes Materials Planning Balancing Factory Capacity Assessing Direct Cost @ Mixes Analyzing Absorption implications

Business Need / Benefit

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How different Functions use Forecast information

ORGANIZATION Sales & Marketing Operations Materials Logistics Finance & Accounting HR MIS Design

KEY VALUE OF A FORECAST Pricing, Promotions, Quotas, Commissions Schedules, Capacity, Capital Continuous supply, Inventory Transportation Planning Cash flow, cost, profits, PE estimates Hiring, recruiting, training Hardware, connectivity, support New products and services

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Forecast accuracy varies over time

Over

Expected Errors

+1

+2

+3

+4 Time in Future (Weeks)

+n

Under

The further into the future, the harder to predict details with accuracy
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Detailed Product Forecast Accuracy will vary by Time Horizon

Current Week should approach 100%

5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100%

Week

Known

High Prob. TBD

Current Month should be greater than 80%

5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100%

Month

Known

High Probability / Influence

TBD

Quarter should be at least 70%

5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100%

Quarter

Known

High Probability and/or can Influence

To Be Determined

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Tracking Forecast Accuracy

Level of Aggregation Item (Mix of individual SKUs) Family Product Line Absolute values and square roots eliminate the possibility of positive and negative variances Channel canceling each other out key for Mix tracking; Customers less critical for Revenue tracking Quantity Time Buckets Final consumer sales
Regular tracking and monitoring with enable Demand SENSING, as well as contribute to increased accuracy of future forecasts

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Relationship of Lead Time, Forecast, Inventory, and Cost

Need to Forecast

Inventory Levels in Pipeline

Cost to Manage

Risk of Excess

Long Lead Time

High

High

Higher

Higher

Short Lead Time

Low

Low

Lower

Lower

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Time Series Forecasts (and Behaviors)

Trend - long-term movement in data Seasonality - short-term regular variations in data Cycle wavelike variations of more than one years duration Irregular variations - caused by unusual circumstances

Random variations - caused by chance

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Graphs help interpret Time Series data (Figure 3.1)

Irregular variatio n

Trend

Cycles
90 89 88 Seasonal variations

* From Stevenson, Operations Management, Ninth Edition, McGraw Hill Irwin

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Relevance of SUPPLY on Forecasts

Historical Sales does not always equal historical Demand Stockouts Substitutions Causal Factors may distort the analysis (pricing, promotions, competitor performance) Scarcity Behavior Allocation Advance buying Hedging Hording

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Guide to selecting Forecasting methods (Table 3.4)

Forecasting Method Moving Average Amount of Historical Data 2 - 3 observations Data Pattern Data should be stationary Data should be stationary Forecast Horizon Preparation Time Personnel Background Little sophistication

Short

Short

Simple exponential 5 - 10 observations smoothing Trend-adjusted exponential smoothing Trend models

Short

Short

Little sophistication

10 - 15 observations 10 - 20; for seasonality at least 5 per season Enough to see 2 peaks and troughs

Trend

Short to medium

Short

Moderate sophistication Moderate sophistication

Trend Handles cyclical and seasonal patterns

Short to medium

Short

Seasonal

Short to medium

Short to moderate Long development time, short time for implementation

Little sophistication

Causal regression models

10 observations per Can handle complex Short, medium, or independent data patterns long variable

Considerable sophistication

* From Stevenson, Operations Management, Ninth Edition, McGraw Hill Irwin

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Selecting the most useful Forecasting technique(s)

No single technique works in every situation

Two most important factors Cost Accuracy Other factors include the availability of: Historical data Computers Time needed to gather and analyze the data Forecast horizon

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Causal Factors
External Market conditions (e.g. paintings when the Painter passes away) New competition Competitors cannot supply Internal Pricing Promotions Incentives

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Barry Bonds Home Run Totals

750 675 600 525

Home Runs

?????????

450 375

300
225 150 75 0 22 23 24 25 26 27 28 29 30 31 32
Age

33

34

35

36

37

38

39

40

41

42

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Other Points to consider

Do not second guess the forecast significant judgment and even debate contribute to the final forecast. Once the forecast is finalized it then becomes the Demand Plan of Record for the enterprise and do not say, If only we got a better forecast The forecast should be generated as a team and managed as a team It is helpful to provide a range of expected Demand A useful application of Confidence Intervals from Statistics

Product Transitions are very difficult to forecast, but require special attention and monitoring New Product Introduction End Of Life
Peter Drucker: The best way to predict the future is to CONTROL it
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