FORECASTING AND METHODS OF FORECASTING Components of Demand

FORECASTING Average Demand

• Method or technique for estimating many – There is no apparent long-term underlying growth
future aspects of a business or other operation. or seasonal trend
• It is used in the practice of customer demand Trend
planning in everyday business forecasting for – The tendency of demand to move upwards or
manufacturing companies. downwards over a period of time
There are 3 Types of Forecasting Seasonal Component
1. Qualitative or Judgmental Methods o Fluctuations that occur periodically with a high
2. Extrapolative or Time series Method
degree of predictability
3. Causal or Explanatory Method
1. Qualitative method Cyclical Movements
 Rely on experts or managers opinion in making o Oscillatory movements of Demand over a
prediction for the future. longer duration of time than a year
 Useful for medium to long range forecasting Random Movements
tasks. o Erratic in nature and cannot be predicted
 Provide a basis for some important decision. because it has no set pattern
Three important qualitative methods are:
 DELPHI TECHNIQUE
QUANTITATIVE TECHNIQUE
– develop forecast through group
o Defined as those techniques which provide the
consensus.
decision makes a systematic and powerful means
 MARKET SURVEYS
of analysis, based on quantitative data. It is a
– involves the use of questionnaires,
scientific method employed for problem solving
consumer panels and tests of new
and decision making by the management.
products and services.
 SCENARIO WRITING
Regression Analysis
– process of analyzing possible future
• Suppose you're a sales manager who's trying to
events by considering alternative
predict next month's numbers. Instinctively, you
possible outcomes.
believe that sales are affected by the weather,
2. EXPLORATIVE METHOD
competitor's promotions, level of consumer
 Use past history of demand.
confidence and on and on.
 Comprised of four separate components:
• Regression analysis is a way to sort out which
o Trend Component,
variables have the most impact and which
o Cyclical Component, should be ignored. The dependent variable is
o Seasonal Component and the main factor that you're trying to predict; the
o Irregular Component. independent variables are the factors you
 The objective of this method is to identify the suspect will impact the dependent variable.
pattern in historic data and extrapolate this
future.
Types of extrapolative method
• Moving Average Method
- Average of demands occurring in
several of the most recent periods.
• Weighted Moving Average
- Allows for varying weighting of old
demands.
• Exponential Smoothing
- Exponentially decreases the weighting
of old demands.
3. Causal forecasting
• A statistical forecasting model based on
historical demand data as well as on variables
believed to influence demand.
There are 2 types of causal forecasting methods
Linear Programming to Find Solutions
o Regression Analysis
• Linear programming is a simple technique that
– a functional relationship is established finds the optimal solution for a complex set of
between variables from the historical
constraints by making a few assumptions.
data and then used to forecast • Using linear programming allows researchers to
dependent variable values.
find the best, most economical solution to a
o Econometric Method problem within all of its limitations, or
– an extension of regression analysis and constraints
include a system of simultaneous
regression equations.
Problem : 240 acres of land
Profit: $40/acre of corn, $30/acre of oats.
Have 320 hours available. Corn takes 2 hours of labor
per acre, oats requires 1 hour of labor per acre. How
many acres of each should be planted to maximize
profits?

Game Theory in Decision Making

 Game theory is a study of the interactions
between several people in which each person's
payoff is affected by the decisions made by
others. All of us use game theory in the
decisions made on a daily basis.
 Game theory is a tool used to analyze strategic
behavior by taking into account how
participants expect others to behave. Game
theory is used to find the optimal outcome from
a set of choices by analyzing the costs and
benefits to each independent party as they
compete with each other.
Game theory is best described using the example of the
Prisoner's Dilemma.
The police have brought in two suspects for a crime and
are interrogating them in separate rooms. The suspects,
who cannot communicate with each other, are offered
the following options:
 Confess and agree to testify against your
partner and you will be set free if your partner
does not confess.
 If your partner confesses and you do not, you
will be convicted and receive a maximum three
years sentence.
 If both of you confess, you will each receive two
years in prison.
 If neither of you confesses, each of you will be
sentenced to prison for one year.
 Which choice should each suspect make?
Confess or not confess?
 In the business world, this type of problem is often
seen in the battle between two companies; take
Pepsi and Coca-Cola, for example.
 Should Pepsi lower its prices? Will Coke respond by
dropping its price? What happens to the profits of
each company in this case? How will profits respond
if each company maintains its high prices?
 Using game theory to construct a payoff for each
alternative will reveal the best course of action for
each company in this pricing dilemma.
Decision trees are another quantitative technique
that managers can use to find the best solution when
faced with uncertainty. It is a flowchart diagram that
identifies all the decision choices and the payoffs from
each alternative. The branches of the tree represent
each decision alternative, and the leaves are the payoffs
A decision tree is a decision support tool that uses a
tree-like graph or model of decisions and their possible
consequences, including chance event outcomes,
resource costs, and utility. It is one way to display an
algorithm that only contains conditional control
statements.

Limitations of Quantitative Techniques
 Quantitative techniques cannot be used to
explain social issues, which make them less
effective to examine sociology. Mathematical
data can show what is happening, but it cannot
explain why. Qualitative research based on
observation is needed for this insight.
Time Series Analysis
 A time series is a time ordered sequence of
observation taken at regular intervals over a
period of time (e.g., hourly, daily, weekly,
monthly, and quarterly, annually).
 The time series data may be measurement of
demand, earnings, profits, shipments,
accidents, outputs, precipitation, productivity
and the consumer price index.
Time series analysis comprises methods for analyzing
time series data in order to extract meaningful statistics
and other characteristics of the data.  Labor
Time series forecasting is the use of a model to predict
future values based on previously observed values.
Two Main Goals
(a) identifying the nature of the phenomenon
represented by the sequence of observations.
(b) forecasting (predicting future values of the time
series variable).
Time Series Components
Trend
Refers to long term upward or downward movement in
the data. Changing income, and cultural changes over
account for such movement.
Seasonality
Refers to short term fairly regular variations generally
related to factors such as the calendar or time of the
day. Restaurants, supermarket, theaters experience
weekly and even daily seasonal variation.
Cycles
Are wavelike variation of more than one year’s
duration. These are often related to a variety of
economic, political and agricultural condition.
Irregular Variations
Are due to unusual circumstances such as sever
weather condition, strike or in major change in a
product or service.
Random Variation
Are residual variations that that remain after all other
behaviors have been accounted for.
Factors of Production
HOW ARE GOODS PRODUCED?
Factors of production
The productive resources used to produce goods and
services.
Factors of production are grouped into four categories:
• Land (Natural Resources)
• Labor (Human Resources)
• Capital
• Entrepreneurship
Land
o What Raw materials are needed to produce
your product?
o The “gifts of nature” that we use to produce
goods and services. All the things we call
natural resources.
o Comes from the air, water, or the earth
o Land, minerals, water
• Renewable SOURCES
o Water, air growing things
• Non-Renewable SOURCES
o Coal, oil
Factor 1: Natural Resources
• Nature supplies raw materials necessary to
make things
• These raw materials are called Natural
Resources
– Example: Chicken noodle soup contains
chicken meat, spices, water, and
vegetables, all of which came from the
nature
• What will your employees have to do to create
your product?
• What work will need to be done to turn your
raw material into your finished product
o Work time and work effort that people
devote to producing goods and
services
• People’s efforts, labor
• Effort can be physical or mental
Factor 2: Human Labor
• Human effort used to produce goods and
services is called labor
• Labor can be physical or mental
• Example: to the soup, farmers raise the animals
and crops, a truck driver drives them to a
factory, and workers operate machinery to mix
and can it (physical labor)
• Someone has to design the machines, and think
of a recipe for the soup (mental labor)
Capital
• equipment and people will you need to create
your product
Physical capital: What tools, machines and factories will
you needed to create your product
Financial capital: funds the firm use to buy physical
capital
Human capital: What knowledge, skills, education and
experience will your employees need to have in order
to produce your product (for example: a seamstress , a
chemist, a computer technician )
  Goods made by people and used to produce
other goods and services
 Tools, instruments, machines, buildings, and
other constructions that have been produced in
the past and that business now use to produce
goods and services.
Factor 3: Capital Resources
• Producing goods and services requires tools and
equipment
• The buildings, machines, supplies, etc. used to
produce are called capital resources, or capital
goods
• Examples: the truck used to drive to the factory,
the machines used to can the soup, and the
factory building itself
Entrepreneurship
• The human resource (PEOPLE) that organized
and combines labor, land, capital.
• The quantity and quality of
entrepreneurship is hard to describe and
measure.
• But we can easily recognize brilliant
entrepreneurs by their enormous
financial success.
• Sam Walton (Wal-Mart), Bill Gates
(Microsoft), and Michael Dell (Dell Computers)
are examples of outstanding entrepreneur's.
Influences on Entrepreneurs
Decision Making
• To realize a profit, produce good/service at a
cost lower than the market price for the good
or service.
• Profit is the money left over from selling a good
or service after the cost of buying productive
resources have been paid.
o Minimize the use of scarce resource in
production
o Maximize the productivity of the factors
used in production to keep cost as low
as possible.
Entrepreneurship:
The 4th Factor
• Making the other 3 factors of production into
something useful often takes creativity and
some risk
• Entrepreneurship is the factor of production
that ties the others together
• Examples: Someone has to decide what to
name the soup, where to sell it, and how much
to charge
Bills of Material
Definition
 A listing of all the subassemblies, intermediates,
parts, and raw materials that go into a parent
assembly showing the quantity of each required
to make an assembly.
 Basically, a bill of material (BOM) is a complete
list of the components making up an object or
assembly.
 It is also part of material requirements planning
(MRP)
TYPES OF BOM
Static (fixed) bill – A bill of material for a part that is
normally made from the same components, labor and
raw materials. Used for standard assemblies,
components, and engineer-to-order customer orders.
Example: – A bill of materials for a standard
chair.
Dynamic (parametric) bill – A bill of material for a
product or part for which size, color, laminate, and
other options can be selected.
Example: – A bill of materials for a Dell computer
Single level bill of material – A bill of material that lists
the materials, parts and labor required to make another
part.
Example: – A bill of materials to make a Dell computer
Multilevel bill of material – A bill of material that lists
the components, assemblies, and materials required to
make a part, the components, assemblies, and materials
required to make each component and assembly of the
part, and so forth.
Example: – A BOM for the battery inside the Dell
computer.
What information is on a BOM?
 Quantity
 Item ID
 Description of Item
 Cost of Item
 Total Project Cost
QUANTITY
Tells user how many of each part is needed for
each project.
Example: –A chair needs 1 seat, 4 legs, 1 back, and 5
nails.
Item ID
Tells us which part to order
Example: – The chair needs a 2PC seat, 5DR legs and 1
inch nails.
Description of Item
Provides a check that the correct item is being
ordered.
Cost of Item
Cost is included to show how much each part is per item
and the total cost of all like parts.
Example: – The cost of a leg is RS 5 per leg. Then the
total price of the legs ordered would be RS20 because
there are 4 legs.
Total Project Cost
Shows the total cost of all items and is also the total
cost of the direct materials used in the project.
Example: – Seat RS10, Back RS5, Leg RS5 per leg, Nail RS
5 per nail
– Total Cost of a chair = 10 + 5 + 5*4 + .5*5 = RS 37.50
Benefits of a BOM
 Help to maintain an accurate record of
information.
 Improve material management through
responding to changes in production.
 Control inventory levels.
 Reduce obsolete parts;
 Control and reduce manufacturing costs;
 Provide what-if capabilities for estimates