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Management Concepts Chapter 06 – Forecasting and Premising

Forecasting and Premising

06.01. Forecasting – Introduction:

 Forecasting is the process of estimation in unknown situations. Business


forecasting is a systematic attempt to probe into the future, so as to
identify the threats and opportunities and achieve goals successfully by
making and implementing well designed plans of action.

 Business forecasting helps in analysing the economic, political and market


information to reduce the risks involved in making business decisions and
long-range plans.

 Forecasts make management think ahead and give singularity of purpose to


planning by concentrating attention on the future. Business forecasting
involves a 'look ahead' approach in business.

 Business forecasting involves a wide range of tools, including simple


electronic spreadsheets, Enterprise Resource Planning (ERP) and Electronic
Data Interchange (EDI) networks, advanced supply chain management
systems, and other Web-enabled technologies.

06.02. Essential Components in Business Forecasting:


Redfield, in a famous article in Harvard Business Review, identified the following
essential elements in business forecasting:

1. Developing the groundwork: The known and available information


regarding the growth of the company, the industry in which the company is
positioned, the growth of the product lines of the company, etc., is put to
investigation in the first stage. The basic purpose is to prepare a ground
work on which future predictions can be based.

2. Estimating future business: Against the backdrop of the information


collected, an estimate of future prospects of business is made by
management. The trends are projected by management after a step-by-step
procedure where the information is put to close scrutiny and analysis. These
probable trends should not be taken as absolute guides to executive action;
they can be taken as intelligent guesses at this stage.

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Management Concepts Chapter 06 – Forecasting and Premising

3. Comparing the actual with estimated results: To ward off dangers arising
from wrong anticipation, a periodic comparison of actuals with estimated
results is made at this stage. The forecast provides the measurement
apparatus and helps in tracking down reasons for major differences resulting
in unanticipated gains/losses.

4. Refining the forecast process: The above three-step process helps


executives in gaining proficiency in constructing dependable forecasts. As
time progresses they are able to refine, sharpen and adjust the forecasting
techniques to meet the changing needs of business.

06.03. Determinants of Business Forecasts:

1. Political stability;
2. Population trends;
3. Price levels;
4. Government controls and fiscal policy;
5. Employment, productivity and national income;
6. Technical environment – some areas have shown great changes, e.g.
computers, and the impact of the speed of developments must be especially
noted.

06.04. Benefits of Forecasting:

1. Since forecasts are the premises or basic assumptions upon which the
manager's planning and decision-making are based, business forecasting
supplies vital facts and pertinent information for successful planning.

2. It helps in bringing a singleness of purpose to planning, that cannot exist


easily otherwise.

3. It improves the quality of managerial planning.


Example: If a company is able to anticipate the future requirements of customers,
it can plan and develop new products in an appropriate way.

4. Forecasting helps in achieving better coordination by focussing attention on


the future. It helps in ensuring a singleness of purpose to planning and
objectives.

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Management Concepts Chapter 06 – Forecasting and Premising

5. Forecasting helps in minimising the costly planning errors.

6. Effective forecasting helps in identifying the environmental forces and


assists in providing for these challenges, though in an imperfect way.
Without business forecasting, individuals as well as organisations are at the
mercy of future events.

7. Forecasting also helps in preparing the organisation for future crisis and
emergencies. The organisation, through adequate planning measures, can
buffer itself against many, if not all, of these unexpected changes. It may
be impossible to evolve necessary shock absorbers completely guard against
business cycles but at least their impact can be fairly assessed, and the
unfavourable consequences can be minimised.

8. It supplies vital information regarding the weak spots in the organisation


thereby paving the way to appropriate control. Once such areas are spotted,
it is easy for managers to establish checkposts for effective control and
sound planning thereafter.

06.05. Limitations of Forecasting:

Forecasts are only estimates of future conditions and not indicators of actual
position. Future is shrouded by shadows of uncertainty. It is quite possible that,
because of uncertainty, the best possible plan may result in losses and a bad plan
in profits. Uncertainty always places severe limitations on the efficacy of
forecasting. Forecasting suffers from the following limitations:

1. Reliability of past data. Although past events are analyzed as a guide to the
future, a question is raised as to the accuracy of these recorded events.

2. Accurate judgment is needed to identify key factors entering the forecast,


interpreting data and selecting methods of analysis and applying them to
problems.

3. Single figure forecasts may be unsatisfactory, as there is a need for


probability to be attached, thereby evaluating the likelihood of the event
occurring.

4. A successful forecast is something of a miracle and often occurs for wrong


reasons. Prophesies of future events is hazardous and in the case of business
undertakings operating in highly volatile and turbulent environments,
forecasting is meaningless.

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Management Concepts Chapter 06 – Forecasting and Premising

5. Forecasting is based largely on predictions and assumptions. Guesswork,


however perfectly made, cannot eliminate the margin of error, the
possibility of mistakes.

6. The forecasting techniques have not been fully developed as yet and there
is no fool proof method of predicting the future. Thus forecasting is more of
an art than a science. Its success largely depends on how skilfully it is put
into practice, how effectively the forecasting techniques have been made,
etc.

06.06. Techniques of Forecasting:

Many scholars have proposed a variety of ways to categorize forecasting


methodologies. The following classification is a modification of the classification
developed by Gordon over two decades ago:

1. Genius forecasting:
This method is based on a combination of intuition, insight, and luck. Psychics and
crystal ball readers are the most extreme case of genius forecasting. Their
forecasts are based exclusively on intuition. Science fiction writers have
sometimes described new technologies with uncanny accuracy.

2. Trend extrapolation:
These methods examine trends and cycles in historical data, and then use
mathematical techniques to extrapolate to the future. The assumption of all these
techniques is that the forces responsible for creating the past will continue to
operate in the future. This is often a valid assumption when forecasting short term
horizons, but it falls short when creating medium and long term forecasts. The
further out we attempt to forecast, the less certain we become of the forecast.

3. Consensus methods:
Forecasting complex systems often involves seeking expert opinions from more
than one person. Each is an expert in his own discipline, and it is through the
synthesis of these opinions that a final forecast is obtained.

4. Cross-impact matrix method:


Relationships often exist between events and developments that are not revealed
by univariate forecasting techniques. The cross-impact matrix method recognizes
that the occurrence of an event can, in turn, affect the likelihoods of other
events.

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Management Concepts Chapter 06 – Forecasting and Premising

5. Simulation methods:
Simulation methods involve using analogs to model complex systems. These
analogs can take on several forms. A mechanical analog might be a wind tunnel for
modelling aircraft performance. An equation to predict an economic measure
would be a mathematical analog. A metaphorical analog could involve using the
growth of a bacteria colony to describe human population growth. Game analogs
are used where the interactions of the players are symbolic of social interactions.

6. Scenario:
The scenario is a narrative forecast that describes a potential course of events.
Like the cross-impact matrix method, it recognizes the interrelationships of system
components. The scenario describes the impact on the other components and the
system as a whole. It is a "script" for defining the particulars of an uncertain
future.

7. Decision trees:
Decision trees originally evolved as graphical devices to help illustrate the
structural relationships between alternative choices. These trees were originally
presented as a series of yes/no (dichotomous) choices. As our understanding of
feedback loops improved, decision trees became more complex. Their structure
became the foundation of computer flow charts.

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Management Concepts Chapter 06 – Forecasting and Premising

8. Economic Forecasting:
Economic forecasting is one of the common types of external forecasting. The
basic aim of economic forecasting is to predict business fluctuations, i.e.,
fluctuations in general economic activity. Depending on the nature of the business,
these fluctuations affect the success or failure of business in various ways.
There are numerous factors known as indicators such as interest rates, stock
prices, level of employment, and many others which are frequently employed to
measure the extent of economic activity in a nation. However, the single-most
important indicator is the gross national product (GNP). GNP is the value of goods
and services produced in the country affects the conditions of many organisations
in an economy:

(a) Extrapolation:

The simplest form of


economic forecast is
that of extrapolation,
which is simply a
projection of the
current trend into the
future. An example of
extrapolation
is shown in the Figure

(b) Econometrics:

This is a mathematical approach in which the main variables are joined together in
a series of equations. It can then be forecasted on the basis of the assumptions
developed from these equations.

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Management Concepts Chapter 06 – Forecasting and Premising

(c) Lead and Lag Method:

In this method, the historic behaviour of various indicators is studied. An


illustration of Lead and lag method is shown in Figure

Conclusion: Combining Forecasts


It seems clear that no forecasting technique is appropriate for all situations. There
is substantial evidence to demonstrate that combining individual forecasts
produces gains in forecasting accuracy. There is also evidence that adding
quantitative forecasts to qualitative forecasts reduces accuracy. Research has not
yet revealed the conditions or methods for the optimal combinations of forecasts.

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Management Concepts Chapter 06 – Forecasting and Premising

06.07. Difference between Planning and Forecasting

Sl
No Particulars Planning Forecasting

1 Meaning Making of decision is Forecasting doesn’t involve


planning. the process of decision
making. It is the due for
planning. It also explains
what is likely to happen in
future.

2 Levels at which In planning final decisions In forecasting suggestions are


decisions are are taken by top level given by middle & lower
taken management. level management.

3 Scope Planning is more Forecasting involves


comprehensive which estimation of future &
includes many sub- provide basis for planning.
processes.

4 Commitment of It is the basic plan of Forecasting may not required


action planning. any Commitment of action
but it is help line in
planning. It also helps for
planning process.

5 Number of The large numbers of Forecasting activity can be


Persons persons are involved in taken by whom it may be
planning process. affected whole of the
organization.

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Management Concepts Chapter 06 – Forecasting and Premising

06.08. Premising:

Premises are assumptions about the future which provide the basic framework for
forecasting and planning activities. As pointed out by Koontz and O' Donnel,
'premises guide planning. They spell out the stage of the expected future event
which is believed will exist when plans operate. They are the expected
environment plans.'

It is an extremely tough task to fit all the future complexities together to make a
forecast. A manager should have some framework to use for analysing the future.
He has to identify certain forecasting 'goals' such as:

1. General economic premises are assumptions about the level of activity in


the total economic system. Generally, Gross National Product (GNP) is
accepted as an indicator of general business activity.

2. Industry premises are the assumptions a manager makes about the


probability of occurrences in his industry.

3. Company premises should start with a comprehensive survey of the


company in relation to its environment.

Tangible premises are those that can be stated in physical and monetary units like
labour hours, production units. Intangible premises defy quantification.

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