Unit- 2

Definition | Types of Demand Forecasting | Need and Significance of Demand

Forecasting | Basic Approaches of Forecasting | Qualitative Forecasting | Types
of Qualitative Forecasting | Quantitative Forecasting | Types of Quantitative
Forecasting | Steps Involved in Demand Forecasting
Supply chain and forecasting software Lack of forecasting in Australia
implementation failure in 2001 failure in 2000-2008

• The system wrongly predict high • Started the business in Australia on

demand for least selling shoes July, 2000 at Sydney
(stock-piling) • By 2008, the stores increased up to
• Predicted low demand for popular 87 without forecast the customer
Air Jordan
footfall
(shortage)
Loss of $100 million Loss of $105 million
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 Definition
• Forecasting is the use of historic data to determine the
direction of future trends
• Forecasting is most commonly used to determine future
sales/demand size as well as budget allocation
• Demand Forecasting is a systematic process of predicting the
future demand for a firm’s product based on the historical data
or experience and judgment of the person related to it

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 Types of Demand Forecasting
Individual/ Each individual production or service
organization estimate demand for their
Micro Level products or services.

Based on Demand as estimated for a group of

Economy Industry Level
similar production or service organizations

Types of Aggregate demand for industrial output by

Macro Level
Forecasting the whole country is carried out

Based on time Short-term Forecast When forecasting is carried out for a

period of 2-3 years.
horizon

Long-term Forecast When time period of forecasting is more

than three years.
Need and significance of demand forecasting
Fulfilling objectives

Preparing the budget

Stabilizing employment and production

Expanding organisation

Taking management decisions

Evaluating performance
 Fulfilling objectives
Every business unit starts with certain pre-decided objectives. Demand
forecasting helps in fulfilling these objectives. An organization estimates the
current demand for its products and services in the market and move forward
to achieve the set goals.

Preparing the budget

Forecasting plays a crucial role in making budget by estimating costs and
expected revenues.
For instance, an organization has forecasted that the demand for its product,
which is priced at Rs. 10, would be 100,000 units. In such a case, the total
expected revenue would be 10* 100000 = Rs. 10, 00, 000. In this way,
demand forecasting enables organizations to prepare their budget.
 Stabilizing employment and production
Helps an organization to control its production and recruitment activities. Producing
according to the forecasted demand of products helps in avoiding the wastage of the
resources of an organization. This further helps an organization to hire human resource
according to requirement. For example, if an organization expects a rise in the demand
for its products, it may opt for extra labor to fulfill the increased demand.

Expanding
Preparing organisation
the budget
Forecasting helps in deciding about the expansion of the business of the organization.
If the expected demand for products is higher, then the organization may plan to
expand further. On the other hand, if the demand for products is expected to fall, the
organization may cut down the investment in the business.
 Taking management decisions
Helps in making critical decisions, such as deciding the plant capacity, determining the
requirement of raw material, and ensuring the availability of labor and capital.

Evaluating performance
Preparing the budget
Helps in making corrections. For example, if the demand for an organization’s
products is less, it may take corrective actions and improve the level of demand by
enhancing the quality of its products or spending more on advertisements.
Basic Approaches of Forecasting

Quantitative Qualitative
Historical data from time Opinion from experts,
series, correlation decision makers or
information customers
 Qualitative Methods

Sales force Consumer

Expert Opinion Delphi Method
Estimates Surveys
 Expert opinion method
• Otherwise known as jury of executives’ opinion
• Under this method, the opinions of a group of high-level
managers often in combination with statistical models, are pooled
to arrive at a group estimate of demand
• The general practice is to bring together top executives from
finance, human resources, marketing, purchasing, and production,
etc., who provide background information, experiences, and
opinions to the board of directors
• This exercise usually leads to a quicker (and often more reliable)
result without the use of elaboration and manipulation of data and
statistical techniques
 Delphi method
• A systematic forecasting method that involves structured
interaction among a group of experts on a subject
• The Delphi Technique typically includes at least two rounds of
experts answering questions and giving justification for their
answers, providing the opportunity between rounds for
changes and revisions
• The multiple rounds, which are stopped after a pre-defined
criterion is reached, enable the group of experts to arrive at a
consensus forecast on the subject being discussed
 Sales force estimates
• In this approach each sales person estimates what sales will be
in his/her region
• This forecast are then reviewed to ensure they are realistic and
then combined at the district and national levels to reach an
overall forecast
 Consumer surveys
• This method solicits input from customers or potential
customers, regarding their future purchasing plans
• It can help not only in preparing a forecast, but also in
improving product design and planning for new products
 Quantitative Methods

Time Series
Causal Methods
Methods

Naïve Moving Exponential Regression

Analysis
Method Average Smoothing

Simple Moving Weighted Moving

Average Average
• The time series technique predicts the simple assumption that
the future is a function of the past
• In time series methods, the historical data were collected at
regular intervals
• In other words, they look at what has happened over a period
of time and use a series of past data for forecasting
• Some of the tools of time series method are Naïve method,
moving average, exponential smoothing and trend projection
 Naïve Method
• This method assumes that, the forecast of any period is equal
to the previous periods actual value
• According to this method, Ft= A(t-1)
Our previous year sale was Year Actual sales Forecast
250 units of car, this year too
250 units
we will sell.…..……. 2015 225 -
2016 200 225
2017 185 200
2018 250 185
2019 230 250
2020 230
 Moving Average
• The moving average forecast uses a number of most recent
actual data values out of several periods to generate a forecast
• It is useful if we can assume that market demands will stay
fairly steady over a period of time

After each period elapses, the absolute Weight is assigned to some time
figure for the oldest period is discarded periods based on the relative importance
and the demand for the newest period is of the particular period. The total of the
added for the next calculation assigned weight will be 1.

Simple Moving Average Weighted Moving Average

 3 year moving average 5 year moving average Weighted moving average (3 year)
Period Orders (A)
1 122
2 91
3 100
4 77 104 102
5 115 89 87
6 58 97 101 101
7 75 83 88 79
8 128 83 85 78
9 111 87 91 98
10 88 105 97 109

11 109 92 103
 Exponential Smoothing
• Exponential smoothing is a sophisticated weighted moving
average forecasting method that is still fairly easy to use
• It involves very little record keeping of past data. Exponential
smoothing is distinguishable by the special way it weighs each
past demand
• The pattern of weights is exponential in form. Demand for the
most recent period is weighted most heavily; the weights
placed on successively older periods decrease exponentially.
 F(t)= ∞At-1+(1- ∞)Ft-1

Exponential Exponential
Smoothing Smoothing
Period Orders (A) (a = 0.2) (a = 0.5)
1 122 122 122
2 91 122 122
3 100 116 107
4 77 113 103
5 115 106 90
6 58 107 103
7 75 98 80
8 128 93 78
9 111 100 103
10 88 102 107

11 99 97
 Causal techniques
• Causal techniques try to establish a cause and effect
relationship between variables
• In the causal model, the effect on dependent variable
is caused by changes in the independent variable(s)
 Regression Method
• Regression model is a causal forecasting technique output that
establishes a relationship between variables
• There is one dependent variable and one or more independent
variables
• Historical data establishes a functional relationship between
the two variables. If there is one independent variable it is
called simple regression, otherwise, it becomes multiple
regression
Y= a+bX
• Identify dependent (y) and independent (x)
variables
• Solve for the slope of the line

b
 XY  n XY

 X  nX
2 2

• Solve for the y intercept

a  Y  bX
• Develop your equation for the trend line
Y=a + bX
Linear Regression Problem: A maker of golf shirts has been tracking the
relationship between sales and advertising dollars. Use linear regression to
find out what sales might be if the company invested $53,000 in advertising
next year.  XY  n XY
b a  Y  bX
X
2
2
 nX

Year Sales $ (Y) Adv.$ (X) XY X^2 30282  451.25147.25

b  3.58
10533  451.25
2
1 130 48 4240 2304
2 151 52 7852 2704 a  Y  b X  147.25  3.5851.25
3 150 50 7500 2500 a  -36.20
4 158 55 8690 3025 Y  a  bX  -36.20  3.58x
5 ???
153.54 53 Y5  -36.20  3.5853  153.54
Tot 589 205 30282 10533
Avg 147.25 51.25
Steps Involved in Demand Forecasting
Specifying the objective

Determine the time horizon

Making the choice of method

Collection of data

Estimation and interpretation of data

 Specifying the objective
• The objective for which the demand forecasting is to be done
must be clearly specified
• The objective may be defined in terms of; long-term or short-
term demand, the whole or only the segment of a market for a
firm’s product, overall demand for a product or only for a
firm’s own product, etc.
• The objective of the demand must be determined before the
process of demand forecasting begins as it will give direction
to the whole research
 Determine the time horizon
• On the basis of the objective set, the demand forecast can
either be for a short-period, say for the next 2-3 year or a long
period
• Many determinants can be assumed constant, while
considering the forecast for short-period
• The determinants may vary significantly while considering the
forecast for long period
 Making the choice of method
• Constitutes one of the most important steps of the demand
forecasting process
• The method of demand forecasting differs from organization to
organization depending on the purpose of forecasting, time
frame, and data requirement and its availability
• The organisation can go for qualitative data or quantitative
data
• Selecting the suitable method is necessary for saving time and
cost and ensuring the reliability of the data
 Collection of data
• Requires gathering primary or secondary data
• Primary data refers to the data that is collected by researchers
through observation, interviews, and questionnaires for a
particular research
• On the other hand, secondary data refers to the data that is
collected in the past; but can be utilized in the present
scenario/research work.
 Estimation and interpretation of data
• Involves making an estimate of the forecasted demand for
predetermined years
• The results should be easily interpreted and presented in a
usable form
• The results should be easy to understand by the readers or
management of the organization