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Chapter 3

Chapter 3 discusses forecasting, defining key terms such as demand forecasting and supply chain management, and emphasizing its importance in business operations. It outlines the steps in the forecasting process, the elements of a good forecast, and various methods, including qualitative and quantitative approaches. Additionally, it highlights the significance of forecast accuracy and provides common measures to evaluate it, such as Mean Absolute Deviation and Mean Squared Error.

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10 views5 pages

Chapter 3

Chapter 3 discusses forecasting, defining key terms such as demand forecasting and supply chain management, and emphasizing its importance in business operations. It outlines the steps in the forecasting process, the elements of a good forecast, and various methods, including qualitative and quantitative approaches. Additionally, it highlights the significance of forecast accuracy and provides common measures to evaluate it, such as Mean Absolute Deviation and Mean Squared Error.

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daryllmalinana
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© © All Rights Reserved
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Chapter 3: Forecasting

Definition of Terms
1. Forecasting – The process of making predictions about future trends based
on historical data and analysis.
2. Demand Forecasting – Estimating future customer demand for a product or
service.
3. Quantitative Forecasting – Forecasting based on mathematical models and
historical data.
4. Qualitative Forecasting – Forecasting based on expert opinions and market
research.
5. Supply Chain Management (SCM) – The coordination of production, inventory,
location, and transportation to optimize efficiency.
6. Lead Time – The time between placing an order and receiving the goods.
7. Forecast Horizon – The period covered by a forecast (short-term, medium-
term, long-term).
8. Forecast Error – The difference between actual and predicted values.
9. Mean Absolute Deviation (MAD) – A measure of forecast accuracy that
calculates the average error.
10.Time-Series Data – Historical data collected over regular time intervals.

Introduction to Forecasting
Forecasting is essential in various business functions, including:
 Operations and production planning
 Inventory management
 Financial budgeting
 Supply chain coordination
It helps businesses make proactive decisions instead of reacting to market changes.
Features Common to All Forecasts
1. Assumption of Past Trends – Most forecasts rely on historical data to
predict future events.
2. Inherent Uncertainty – No forecast is 100% accurate; there is always a
degree of error.
3. Aggregation of Data – Forecasts can be made for individual products,
entire industries, or economies.
4. Accuracy Improves with Shorter Time Horizons – Forecasts for short-
term periods tend to be more reliable than long-term ones.
Discussion: Why do companies rely on forecasts despite
their inherent uncertainty?
Elements of a Good Forecast
A high-quality forecast should be:
 Timely: Useful for decision-making before critical deadlines.
 Accurate: Minimized error rates improve reliability.
 Reliable: Consistently correct over multiple forecasting periods.
 Cost-Effective: The benefits should outweigh the costs of creating forecasts.
 Easy to Understand: Clear and interpretable for decision-makers.
Forecasting and the Supply Chain
Accurate forecasting is crucial for supply chain efficiency. It helps:
 Reduce excess inventory and stockouts
 Improve supplier coordination
 Optimize transportation and logistics
 Balance demand and supply
Case Study: How does Amazon use forecasting to optimize its supply chain?
Steps in the Forecasting Process
1. Determine the Purpose of the Forecast – Identify why the forecast is
needed.
2. Establish a Forecasting Horizon – Choose between short-term
(weeks/months) and long-term (years).
3. Gather and Analyze Data – Use historical sales, market trends, and other
relevant information.
4. Select a Forecasting Technique – Choose qualitative or quantitative
approaches.
5. Prepare the Forecast – Develop the forecast using the selected method.
6. Monitor and Update the Forecast – Regularly compare actual results with
forecasts to improve accuracy.
Forecast Accuracy
Measuring accuracy is crucial to refining forecasting methods. Common accuracy
measures include:
 Mean Absolute Deviation (MAD) – Measures the average absolute errors.
 Mean Squared Error (MSE) – Squares each error before averaging to
emphasize larger errors.
 Mean Absolute Percentage Error (MAPE) – Expresses error as a
percentage of actual values.

1. Mean Absolute Deviation (MAD)

Interpretation: On average, the forecast is off by 7 units per month.

2. Mean Squared Error (MSE)


Interpretation: The squared errors average 55, emphasizing larger errors more
than MAD.

3. Mean Absolute Percentage Error (MAPE)

Interpretation: The forecast error is 4.91% of actual sales on average.

Here are the meanings of the symbols used in the calculations for MAD, MSE, and
MAPE:

Approaches to Forecasting
Forecasting methods fall into two categories:
 Qualitative Methods (based on judgment and intuition)
o Delphi Method (expert consensus)
o Market Research

o Executive Opinions

 Quantitative Methods (based on numerical data and statistical models)


o Time-Series Models

o Causal Models

Forecasts Based on Time-Series Data


Time-series forecasting uses historical data to predict future trends. Common
methods include:
1. Moving Averages – Averages past data points to smooth fluctuations.
2. Exponential Smoothing – Gives more weight to recent observations.
3. Trend Projection – Identifies patterns in long-term data.
4. Seasonal Adjustments – Adjusts forecasts based on recurring seasonal
trends.
Example: Predicting retail sales during holiday seasons using time-series models.
Discussion: Why are time-series forecasts more effective in stable industries
compared to rapidly changing industries?

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