PRODUCTION AND

OPERATIONS
MANAGEMENT
Forecasting and Capacity planning
• Steps in forecasting
• Forecast approaches and techniques
• Choosing forecasting technique and using forecast information
• Defining and measuring capacity
• Importance of capacity decisions
• Determinants of effectiveness
• Determining capacity requirements
Steps in forecasting

Everybody makes forecasts everyday. One asks questions to predict or

approximate future occurrences.
Forecasting is the process of making predictions of the future, based on
past and present data and most commonly by analysis of trends.
To make forecasts, we take into account two kinds of information;
current factors or conditions as well as past experience in a similar
situation.
Sometimes we rely more on one than the other, depending on which
approach seems more relevant at the time.
Steps in forecasting

Likewise, and importantly, businesses need to make forecasts.

A business that guesses wrongly on what customers are going to need
in the far or near future, will get stuck with items that will not be
bought.
That business is bound to fail than a competitor that scientifically
studies the buying patterns of customers in the past, and factors in
current requirements, and come up with reasonable approximation of
what customers might need in the far and near future.
Thus, is forecasting; simply a statement about the future anticipations.
Steps in forecasting
• Nature of forecasts
There are common features that manifest in all forecasts:
Forecasting techniques generally assume that the same underlying causal
factors that existed in the past will continue to exist in the future.
This brings in an element of unreliability. It is therefore important that various
factors have to be taken into consideration when making the forecast, e.g. tax
changes, weather or natural occurrences, changes of competing products, etc.
Forecasts are rarely perfect; actual results usually differ from predicted values.
It is extremely difficult to predict precisely how a large number of related
factors will affect the variable in question.
Allowances for inaccuracies should therefore always be factored in.
Steps in forecasting
Forecast accuracy diminishes as the time period of the forecast
increases.
Forecasts are divided into three, depending on the time horizon.
Long range forecasts (3+ years) have a low rate of accuracy.
Medium range forecasts (1 to 3 years) have an average rate of
accuracy.
Short range forecasts (less than 1 year) have a fairly high rate of
accuracy.
The implication is that robust businesses that have products that are
in the introduction and growth stage need to emphasis on short range
forecasts to reduce failure of their plans.
Steps in forecasting
• Elements of a good forecast
The forecast should be timely. Usually, a certain amount of
time allowance is needed to respond to the information
contained in a forecast. For example, capacity cannot be
expanded overnight, nor can inventory levels be changed
immediately. Hence, much as accuracy diminishes with time
horizon, the forecasting horizon must still cover the time
necessary to implement possible changes.
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
Steps in forecasting
The forecast should be reliable such that it should have a higher degree of
working consistently. A technique that sometimes provides a good forecast
and sometimes a poor one will leave users with the uneasy feeling of
uncertainty whether the result is accurate or not.
The forecast should be expressed in meaningful units. If the forecast is
about finances, it should be clear how many kwachas will be needed; if its
regarding production, it should clearly state how many units will be needed;
if it is about Human Resources, it should clearly answer how many people of
what skills will be needed; and schedulers need to know what machines and
skills will be required.
Therefore, the choice of units depends on the needs of the user of the
forecast.
Steps in forecasting
The forecasting technique should be simple to understand
and use. It should put into consideration the user of the
forecast if they will be able to easily understand the method
used in presenting the forecast, e.g. graphs and charts.
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.
Steps in forecasting
• Steps in forecasting
The forecasting process has six basic steps:
Determine the purpose of the forecast. What will the forecast be
used for? This will provide an indication of the level of detail and
accuracy required.
Establish a time horizon. The forecast must indicate a time limit,
(whether long, mid or short range), keeping in mind that accuracy
decreases as the time horizon increases.
Select a forecasting technique. This depends on the type and
availability of data required to be collected.
Steps in forecasting
Gather and analyze relevant data. Before a forecast can be prepared, data
must be gathered and analyzed. Identify any assumptions that are made in
conjunction with preparing and using the forecast.
Perform/conduct the forecast using an appropriately and relevant chosen
technique.
Implement and monitor the results. A forecast without implementation is a
wastage of business resources. The forecast has to be constantly monitored
to ensure that it is achieving its intended purpose.
If it is going off course, find out what has to be revised whether it is the
technique, the data collected, the assumptions, etc., and then prepare a
revised forecast.
Forecast approaches and techniques
• Forecasting approaches
There are basically two approaches of forecasting, qualitative and quantitative.
o Qualitative
The method consists mainly of subjective inputs, which often are not represented
numerically.
Qualitative approach involves collecting and appraising judgements, opinions, even best
guesses from ‘experts’ to make a prediction, as well as past performances.
The approach permits inclusion of soft information (e.g., human factors, personal
opinions, hunches or impressions) in the forecasting process.
In short:
It is used when situation is vague and little data exists e.g. new products, new technology
and new markets.
It involves intuition (insticts) and experience.
Forecast approaches and techniques
 Qualitative techniques
Jury of executive opinion/Panel approach
Just as panels of football pundits gather to speculate about likely
outcomes, so too do politicians, business leaders, stock market
analysts, banks and airlines.
The panel acts like a focus group, allowing everyone to talk openly and
freely.
In business, a small group of upper-level managers (e.g., in marketing,
operations, and finance) may meet and collectively develop a forecast.
Forecast approaches and techniques

The advantage is that it brings together the considerable knowledge

and talents of various managers.
It however has a bandwagon effect, a phenomenon in which other
people adopt ideas, beliefs and opinion just because many people or
some influential individuals have adopted them.
Also, although more reliable than one person’s views, the panel
approach still has the weakness that everybody, even the experts, can
get it wrong.
Forecast approaches and techniques
The Delphi method
This method is implemented to reduce the bandwagon effect.
There are basically three different participants in this method:
 Staff that administer the survey,
 Respondents that are experts in the field being forecasted,
 Decision makers responsible for evaluating the responses and making decisions.
A number of experts that will participate are selected.
A questionnaire is developed and sent to the experts, whose replies will be anonymous, not
revealed to the other participants.
Other series of questionnaires will be developed based on the information on the previous
responses, until a consensus is reached, or a prominent forecast is achieved.
Another important element of this approach is to allocate weights to the individuals and their
suggestions based on, for example, their experience as well as past success in forecasting.
With this method, it is imperative to construct an appropriate questionnaire, selecting an
appropriate panel of experts and trying to deal with their inherent biases.
Forecast approaches and techniques
Sales force opinions
The sales staff or the customer service staff is often a good source of
information regarding forecasts because of their direct contact with
consumers.
They are often aware of any plans the customers may be considering
for the future.
There is however an element of conflict of interest with this method
when the forecast is on sales. The sales personnel may be attempted to
give a lower forecast so that they appear to having beat the targets.
Forecast approaches and techniques
Consumer surveys
Because it is the consumers who ultimately determine demand, it is only natural
to solicit input from them.
The ideal scenario is to contact each customer. However, due to large numbers of
customers, businesses can use sampling, by selecting a certain number of
customers to solicit forecasting information from.
Although this technique is advantageous as the information is directly coming
from the users, it has its own drawbacks.
It requires a business to have sufficient knowledge and skills on constructing
survey questionnaires, administering them, and correctly interpreting the
results for valid information.
The technique is also time consuming.
Forecast approaches and techniques
o Quantitative
These use numerical data in order to come up with a forecast.
It involved mainly on analyzing objective, or hard, data. This approach usually
avoids personal biases that sometimes contaminate qualitative methods.
In practice however, either or both approaches might be used to develop a
forecast.
If conditions prevail, it is better to use a combination of both so that weaknesses
of each are cancelled by the other.
In short:
It is used when situation is stable and historical data exist, e.g. existing products
and markets.
Involves mathematical techniques.
Forecast approaches and techniques
 Quantitative techniques
Naive approach
This method is very simple as it considers the last period actual
observation to be the forecast of the next period.
It assumes that demand in next period is the same as demand in the most
recent period.
It works on the assumption that all causal variables in the previous period
will remain constant in the next period.
For example, if January sales were 58 units, then the February forecast of
sales will be 58 units.
Forecast approaches and techniques
Moving average
This is a series of arithmetic means.
Moving average =∑ demand in previous n periods
n
Example
Actual 3-Month
Month Shed Sales Moving Average

January 10
February 12
March 13
April 16 (10 + 12 + 13)/3 = 11 2/3
May 19 (12 + 13 + 16)/3 = 13 2/3
June 23 (13 + 16 + 19)/3 = 16
July 26 (16 + 19 + 23)/3 = 19 1/3
Weighted Moving Average

 Used when trend is present

 Older data usually less important
 Weights based on experience and intuition

∑ (weight for period n)

x (demand in period n)
Weighted
moving average = ∑ weights
 Weights Applied Period
3 Last month
2 Two months ago
1 Three months ago
6 Sum of weights

Actual 3-Month Weighted

Month Shed Sales Moving Average

January 10
February 12
March 13
April 16 [(3 x 13) + (2 x 12) + (10)]/6 = 121/6
May 19 [(3 x 16) + (2 x 13) + (12)]/6 = 141/3
June 23 [(3 x 19) + (2 x 16) + (13)]/6 = 17
July 26 [(3 x 23) + (2 x 19) + (16)]/6 = 201/2
Exponential Smoothing

 Form of weighted moving average

 Weights decline exponentially
 Most recent data weighted most
 Requires smoothing constant ()
 Ranges from 0 to 1
 Subjectively chosen
 Involves little record keeping of past data
 Exponential Smoothing

w forecast = last period’s forecast

+  (last period’s actual demand
– last period’s forecast)

Ft = Ft – 1 + (At – 1 - Ft – 1)
where Ft = new forecast
Ft – 1 = previous forecast
 = smoothing (or weighting)
constant (0    1)
 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20
 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

 Exponential Smoothing
Example
Predicted demand = 142 Ford Mustangs
Actual demand = 153
Smoothing constant  = .20

New forecast = 142 + .2(153 – 142)

= 142 + 2.2
= 144.2 ≈ 144 cars
 Effect of Smoothing
Constants

Weight Assigned to
Most 2nd Most 3rd Most 4th Most 5th Most
Recent Recent Recent Recent Recent
Smoothing Period Period Period Period Period
Constant () (1 - ) (1 - )2 (1 - )3 (1 - )4

 = .1 .1 .09 .081 .073 .066

 = .5 .5 .25 .125 .063 .031

Capacity
• Meaning of capacity
Capacity refers to an upper limit or ceiling on the load that an operating unit
can handle.
The operating unit might be a plant, department, machine, store, or worker.
It is the throughput or number of units a facility can hold, receive, store, or
produce.
A definition of capacity is however significantly deficient if it does not include
the time factor.
Capacity therefore should be understood as a measure of an organization's
ability to provide customers with services or goods in the amount requested at
the time requested.
Capacity
• Capacity measures
Design capacity
Design capacity is the theoretical maximum output of a system in a given period under
ideal conditions.
It is basically the total of how much a system can produce given all circumstance allow full
production.
Effective capacity
Effective capacity is the capacity a firm expects to achieve given its current operating
constraints.
It is often lower than design capacity.
Basically, design capacity will have to be higher because of constraints e.g. maintenance,
production of scrap or defect products, absenteeism of employees, shortages of materials,
etc.
Hence, design capacity minus the allowance for the constraints is the effective capacity.
Capacity
• Capacity related concepts
Actual output
This is the rate of output that is actually achieved in production.
Efficiency
Efficiency is how the production facility is used in comparison with standard.
The standard is the effective capacity, as it represents the real capacity after ignoring the
allowance capacity.
It is therefore calculated as:
Actual output
Efficiency =
Effective capacity
Efficiency is better expressed as a percentage.
Capacity
Utilisation
This is the ratio of actual output to the design capacity.
It represents how much of the business’ total capacity is put into actual
usage.
Utilisation = Actual output
Design capacity
Capacity
• Illustration
Design capacity: 250 units per day
Effective capacity: 176 units per day
Actual output: 170 units per day

Efficiency = 170 units per day X 100

176 units per day
= 97%

Utilisation = 170 units per day X 100

250 units per day
= 68%
Capacity
• Importance of capacity decisions
Impacts ability to meet future demands: A business satisfies demand
if it is able to produce in the amount as required by the customer, as
well at the time as required by the customer.
Affects operating costs: Capacity has a direct bearing on costs. If
production capacity is idle, investment in the facilities and equipment
is not generating any income and reducing potential profit.
Likewise, if capacity is being over utilised due to poor planning, there
are costs related to poor quality of products or services produced due
to pressure and stress on workers and machines.
Capacity
Major determinant of initial costs: Capacity is one of the determining factors of the
initial cost of investment in a business.
It is therefore important to determine the optimum and practical capacity of new
businesses as it has an impact of product or service pricing in the early stages.
Affects competitiveness: Capacity has an effect on the speed of delivery, as the
more capacity the business has, the quicker it is likely in satisfying demand in the
quantities and time demanded by the customer. This gives a business a
competitive advantage.
Affects the ease of management: Scheduling of machines, labor, and other factors
becomes easier if a business has enough capacity. This reduces pressure on
management, hence time to concentrate on other important managerial issues.
Capacity
• Determinants of effective capacity
Effective capacity is the usable capacity after taking into consideration constraining
factors, hence increasing effective capacity leads to increase in capacity utilisation.
However, there re several factors that affect effective capacity:
Facilities
Facilities play a role on how much potentially a business can produce.
Size of facilities can dictate how much to hold, as well as room for expansion of
production.
Location of facilities also can affect labour supply, energy sources, availability of raw
materials, all of which eventually affect effective capacity.
Facility layout can also affect how smooth operations can be done hence affecting
capacity to produce.
Capacity
Human factors
Employees that actually do the job on the ground are a very important
determinant of capacity.
Employees that are trained and motivated are likely to produce more than
untrained and unmotivated employees.
Process factors
The manner in which work is arranged has a direct impact on capacity.
Work process that is not well arranged can take longer to produce, hence
decreasing capacity.
Also, work processes that produce defects take longer to produce due to
inspection and corrections.
Capacity
Product/Service factors
Generally, the more uniform the output, the more chances there are
for standardization of methods and materials, which leads to greater capacity.
Businesses that produce a wide range of products using same facilities will take
longer due to frequent adjustments, hence reducing the potential capacity.
External factors
There are other factors that are beyond the control of a business that have an effect
on its capacity to produce.
Regulations regarding production, for example requiring third party inspectors can
increasing waiting period, hence reduction in capacity to produce.
Another example can be restriction or regulation on the maximum hours an
employee can work, this has a direct impact on capacity