Managers study sales forecasts, for example, to take decisions on working capital needs, the size of the work

force,
inventory levels, the scheduling of production runs, the location of facilities, the amount of advertising and sales
promotion, the need to change prices, and many other problems.

Forecasting is a process of estimating a future event by casting forward past data.

Applications of forecasting

Forecasting the need for raw materials and spare parts (Many companies need to maintain an inventory
of spare parts to enable them to quickly repair either own equipment or their products sold or leased to
customers.)
Forecasting Staffing Needs (e.g., travel, tourism, entertainment, legal aid, health services, financial,
educational, design, maintenance, etc.).
Forecasting in a rural setting
Cooperative milk producers, union operates in a certain district. The products it manufactures, the
production capacities it creates, the manpower it recruits, and many more decisions are closely linked
with the forecasts of the milk it may procure and the different milk products it may see. Milk being a
product which has a ready market, is not difficult to sell. Thus demand forecasting for products may not
be a very dominant issue for the organization. However, the forecast of milk procurement is a crucial
issue as raw milk is a highly perishable commodity and building up of adequate processing capacity is
important for the dairy. The milk procurement forecast also forms an important input to the production
planning process which includes making decisions on what to produce, how much and when to produce.

Grass Roots

Grass roots forecasting builds the forecast by adding successively from the bottom. The assumption here is that the
person closest to the customer or end use of the product knows its future needs best. Though this is not always true,
in many instances it is a valid assumption, and it is the basis for this method.
Forecasts at this bottom level are summed and given to the next higher level. This is usually a district warehouse,
which then adds in safely stocks and any effects of ordering quantity sizes. This amount is then fed to the next level,
which may be a regional warehouse. The procedure repeat until it becomes an input at the top level, which, in the
case of a manufacturing firm, would be the input to the production system.
Market Research:
Firms often hire outside companies that specialize in market research to conduct this type of forecasting. You may
have been involved in market surveys through a marketing class. Certainly you have not escaped telephone calls
asking you about product preferences, your income, habits, and so on.
Market research is used mostly for product research in the sense of looking for new product ideas, likes and dislikes
about existing products, which competitive products within a particular class are preferred, and so on. Again, the
data collection methods are primarily surveys and interviews.
Panel Consensus:
In a panel consensus, the idea that two heads are better than one is extrapolated to the idea that a panel of people
from a variety of positions can develop a more reliable forecast than a narrower group. Panel forecasts are developed
through open meetings with free exchange of ideas form all levels of management and individuals. The difficulty
with this open style is that lower employee levels are intimidated by higher levels of management. For example, a
salesperson in a particular product line may have a good estimate of future product demand but may not speak up to
refute a much different estimate given by the vice president of marketing. The Delphi technique (which we discuss
shortly) was developed to try to correct this impairment to free exchange.
When decisions in forecasting are at a broader, higher level (as when introducing a new product line or concerning
strategic product decisions such as new marketing areas) the term executive judgment is generally used. The term is
self-explanatory: a higher level of management is involved.
Historical Analogy:
The historical analogy method is used for forecasting the demand for a product or service under the circumstances
that no past demand data are available. This may specially be true if the product happens to be new for the
organization. However, the organization may have marketed product(s) earlier which may be similar in some
features to the new product. In such circumstances, the marketing personnel use the historical analogy between the
two products and derive the demand for the new product using the historical data of the earlier product. The
limitations of this method are quite apparent. They include the questionable assumption of the similarity of demand
behaviors, the changed marketing conditions, and the impact of the substitutability factor on the demand.
Delphi Method:
As we mentioned under panel consensus, a statement or opinion of a higher-level person will likely be weighted
more than that of a lower-level person. The worst case in where lower level people feel threatened and do not
contribute their true beliefs. To prevent this problem, the Delphi method conceals the identity of the individuals
participating in the study. Everyone has the same weight. A moderator creates a questionnaire and distributes it to
participants. Their responses are summed and given back to the entire group along with a new set of questions.
The Delphi method was developed by the Rand Corporation in the 1950s. The step-by-step procedure is
1) Choose the experts to participate. There should be a variety of knowledgeable people in different areas.
2) Through a questionnaire (or e-mail), obtain forecasts (and any premises or qualification captions for the
forecasts) from all participants.
3) Summarize the results and redistribute them to the participants along with appropriate new questions.
4) Summarize again, refining forecasts and conditions, and again develop new questions.
5) Repeat Step 4 if necessary. Distribute the final results to all participants.

The Delphi technique can usually achieve satisfactory results in three rounds. The time required is a function of the
number of participants, how much work is involved for them to develop their forecasts, and their speed in
responding.

Time-Series Methods

A time series refers to the past recorded values of the variables under consideration. The values of the variables
under consideration in a time-series are measured at specified intervals of time. These intervals may be minutes,
hours, days, weeks, months, etc.

The Naive Methods

The forecasting methods covered under this category are mathematically very simple. The simplest of them uses the
most recently observed value in the time series as the forecast for the next period. Effectively, this implies that all
prior observations are not considered. Another method of this type is the free-hand projection method. This
includes the plotting of the data series on a graph paper and fitting a free-hand curve to it. This curve is extended
into the future for deriving the forecasts. The semi-average projection method is another naive method. Here, the
time-series is divided into two equal halves, averages calculated for both, and a line drawn connecting the two semi
averages. This line is projected into the future and the forecasts are developed.
Illustration 6.1: Consider the demand data for 8 years as given. Use these data for forecasting the demand for the
year 1991 using the three nave methods described earlier.

Solution: The forecasted demand for 1991, using the last period method = actual sales in 1990 = 117 units.
The forecasted demand for 1991, using the free-hand projection method = 119 units. (Please check the results using
a graph papers!)
The semi-averages for this problem will be calculated for the periods 1983-86 and 1987-90. The resultant semi-
averages are 103.75 and 112.75. A straight line joining these points would lead to a forecast for the year 1991. The
value of this forecast will be = 120 units

6.6.2 Simple Moving Average Method

When demand for a product is neither growing nor declining rapidly, and if it does not have seasonal characteristics,
a moving average can be useful can be useful in removing the random fluctuations for forecasting. Although moving
averages are frequently centered, it is more convenient to use past data to predict the following period directly. To
illustrate, a centered five-month average of January, February, March, April and May gives an average centered on
March. However, all five months of data must already exist. If our objective is to forecast for June, we must project
our moving average- by some means- from March to June. If the average is not centered but is at forward end, we
can forecast more easily, through we may lose some accuracy. Thus, if we want to forecast June with a five-month
moving average, we can take the average of January, February, March, April and May. When June passes, the
forecast for July would be the average of February, March, April, May and June.
Although it is important to select the best period for the moving average, there are several conflicting effects of
different period lengths. The longer the moving average period, the more the random elements are smoothed (which
may be desirable in many cases). But if there is a trend in the data-either increasing or decreasing-the moving
average has the adverse characteristic of lagging the trend. Therefore, while a shorter time span produces more
oscillation, there is a closer following of the trend. Conversely, a longer time span gives a smoother response but
lags the trend.
The formula for a simple moving average is ......123AAAAttttFt
where, F = Forecast for the coming period, n = Number of period to be averaged n
t
and A , A , A and so on are the actual occurrences in the in the past period, two periods ago, three periods ago
t-1 t-2 t-3
and so on respectively. n + + + + =
152
Illustration 6.2: The data in the first two columns of the following table depict the sales of a company. The first two
columns show the month and the sales.
The forecasts based on 3, 6 and 12 month moving average and shown in the next three columns.
The 3 month moving average of a month is the average of sales of the preceding three months. The reader is asked
to verify the calculations himself.

The 6 month moving average is given by the average of the preceding 6 months actual sales.
For the month of July it is calculated as
Julys forecast = ( Sum of the actual sales from January to June ) / 6
= ( 450 + 440 + 460 + 410 + 380 + 400 ) / 6
= 423 ( rounded )
For the forecast of January by the 12 month moving average we sum up the actual sales from January to December
of the preceding year and divide it by 12.

6.6.3 Weighted Moving Average

Whereas the simple moving average gives equal weight to each component of the moving average database, a
weighted moving average allows any weights to be placed on each element, providing, of course, that the sum of all
weights equals 1. For example, a department store may find that in a four-month period, the best forecast is derived
by using 40 percent of the actual sales for the most recent month, 30 percent of two months ago, 20 percent of three
months ago, and 10 percent of four months ago. If actual sales experience was
Month 1 Month Month Month Month5
2 3 4
100 90 105 95 ?
6.6.4 Exponential Smoothing
In the previous methods of forecasting (simple and weighted moving average), the major drawback is the need to
continually carry a large amount of historical data. (This is also true for regression analysis techniques, which we
soon will cover) As each new piece of data is added in these methods, the oldest observation is dropped, and the new
forecast is calculated. In many applications (perhaps in most), the most recent occurrences are more indicative of the
future than those in the more distant past. If this premise is valid that the importance of data diminishes as the
past becomes more distant - then exponential smoothing may be the most logical and easiest method to use.
The reason this is called exponential smoothing is that each increment in the past is decreased by (1-). If is 0.05
for example, weights for various period would be as follows ( is defined below):
Weighting at = 0.05
0
Most recent weighting = (1- ) 0.0500
1
Data one time period older = (1- ) 0.0475
2
Data two time periods older = (1- ) 0.0451
3
Data three time periods older = (1- ) 0.0429
Therefore, the exponents 0, 1, 2, 3 and so on give it its name.
The method involves the automatic weighting of past data with weights that decrease exponentially with time, i.e.
the most current values receive a decreasing weighting.
The exponential smoothing technique is a weighted moving average system and the underlying principle is that the
New Forecast = Old Forecast + a proportion of the forecast error
The simplest formula is
New forecast = Old forecast + (Latest Observation Old Forecast)
where (alpha) is the smoothing constant.
Or more mathematically,
F = F + (A F )
t t-1 t-1 t-1
i.e F = A + (1- ) F
t t-1 t-1
Where
F = The exponentially smoothed forecast for period t
t
F = The exponentially smoothed forecast made for the prior period
t-1
A = The actual demand in the prior period
t-1
= The desired response rate, or smoothing constant

Illustration 6.4: The data are given in the first two columns and the forecasts have been prepared using the values
of as 0.2 and 0.8.
Exercise on estimating forecasting rural products

1.