ECON 332

Business Forecasting Methods

Chapter 1
Prof. Kirti K. Katkar
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Why Business Forecasting?

•A must for planning and decision making
Stakeholder Forecasting Entities Sample Uses

Accounting Costs, Revenues Tax Planning

Human Resources Attrition, Workload New Employee Recruitment

and Benefits Planning
Finance Cash Requirements Debt and Equity
requirements
Production Bill of Materials, Raw Material Purchases,
Finished products Inventory of finished goods
Marketing Sales Promotion budgets
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Forecasting in Action
• Operations Planning & Control – Inventory Management,
Sales force Management, Production Planning, Product
Planning etc.
• Economics – Government-policy organizations, Private
forecasting – GDP, unemployment, consumption, investments,
price levels, interest rates, housing starts etc.
• Financial asset management – ROA, exchange rates,
commodity prices
• Financial risk management – Volatility: asset returns, pricing
options and other derivatives
• Demography – Populations of countries, regions by age, sex,
race, government expenditures, target marketing
• Crisis Management – Probabilities of hurricanes, fires,
defaults, currency devaluations etc.
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Business Forecasting Illustrations

• Columbia Gas
– Design Day Forecasts
• Determine gas supply, transportation capacity and
storage capacity
• Use in supply and capacity planning
– Daily Operational Forecasts
• Determine demand
• Use in spot sales/ purchases
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Business Forecasting Illustrations (Contd.)

• American Airlines
– Revenue Forecasts
• Top down industry share approach
• Passenger traffic: the basic unit
– Long-term Equipment Planning Forecast
• Derived demand for capacity
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Public & Not-for-Profit Forecasting

Illustrations
• Police Patrol Services
– Basic measure: call for services workload per district (W)
• Influencing factors
– Absolute population (POP)
– Arrest (ARR)
– Affluence (AFF)
– Vacancy (VAC)
– Population density (DEN)
– Multiple regression model
W = 5.66 + 1.84POP + 1.70ARR – 0.93AFF + 0.61VAC +0.13DEN
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Supply-Chain Management
“The integration of business
processes from end user
through original suppliers
that provides products,
services, and information
that add value for
customers.”

Producers
Distributors
Forecasting for
Consumers
Maximum efficiency
Firm cost control
Meeting customer demand
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Forecasting.. A Blend of Art & Science

Given solid understanding of business/

underlying phenomenon
• 80% Quantitative/ Mathematical/ Objective/
Scientific
• 20% Qualitative/ Judgmental/ Subjective/
Artistic
As a result…
• Subjective forecasting methods
• Quantitative forecasting methods
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Subjective Forecasting Methods

• Sales force composites

• Surveys of customers and the general
population
• Jury of executive opinion
• The Delphi method
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New Product Forecasting

• No hard data available

• Combined subjective/ quantitative forecasts
– Similar product demand profile
– Similar product diffusion rate
– Target customers/ market segment potential
– Customer survey on intention to purchase
– Market share objective
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Table 1-1
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Product/ Business Life Cycle

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Diffusion Curves
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Advantages & Disadvantages of Subjective

Methods
Advantages
• Does not rely on large amounts of data or
mathematical background
• Widely accepted and understood
Disadvantages
• Almost always biased
• Not consistently accurate and reproducible
• Takes years of experience to convert intuitive
judgment into good, usable forecasts
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Quantitative Forecasting Methods

Deterministic Models

Stochastic/ Probabilistic Models

• Naïve models
• Moving averages and exponential smoothing
• Bivariate regression models
• Multiple regression models
• Time series decomposition models
• Auto-Regressive Integrated Moving Average (ARIMA)
models
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Naïve Models
1. Next period forecast will be identical to the present
period actual.
Ft = At-1
2. Next period forecast will be equal to the present
period actual modified by a fraction of difference
between the two most current actuals.
Ft = At-1 + P(At-1 – At-2 )

where F – Forecast, A – Actual, and

P – Proportional Fraction
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Illustration of Naïve Forecast of
Unemployment Rate (UR)

Figure 1-1
Actuals
1-19 UR Forecast (URF) Using the First Naïve
Model
URF(t) = UR(t-1)

Figure 1-2
1-20 UR Forecast (URF2) Using the Second
Naïve Model
URF2(t) = UR(t-1) + P(UR(t-1) – UR(t-2), P = 0.5

Figure 1-3
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Forecast Evaluation Measures – Accuracy &

Precision
•Model Calibration
–Model fit
–Accuracy and precision for historical data
•Evaluation Measures
–Mean Error (ME)

∑(A − F ) t t

ME = n
– Mean Absolute Error (MAE)
∑ A −Ft t
MAE =
n
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Forecast Evaluation Measures – Accuracy &

Precision (Contd.)
•Evaluation Measures [ ( At − Ft ) / At ]
Mean Percentage Error (MPE) =
n
Mean Absolute Percentage Error (MAPE)
∑ (A − F ) / A
t t t
= n
Mean-Squared Error (MSE)

= ∑ − 2
( At Ft )
n
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Forecast Evaluation Measures – Accuracy &

Precision (Contd.)
• Evaluation Measures
Root Mean-Squared Error (MSE)

=
∑ ( At − F t ) 2

Theils’ U =
∑ ( At − Ft ) 2

∑ (A − A
t )2
t −1

RMSE ( Model )
=
RMSE ( NaiveModel )
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Table 1-5
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Using Multiple Models/ Forecasts to Forecast a

Range
• No one model is consistently accurate
• Typical range
– Most Optimistic
– Most Likely
– Most Pessimistic
• Unemployment Rate Forecast Illustration: For a given
time period using two naïve models URF and URF2
– Use lowest forecast as Most Optimistic
– Use highest forecast as Most Pessimistic
– Most Likely = (URF + URF2)/2
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Typical Sources of Data

• Internal Records
– Periodic product/ company sales, # employees, production
levels, shipments, orders received, orders fulfilled, repair
orders, inventory levels
Forecasting Methods: Naïve models, time series
decomposition, exponential smoothing,
ARIMA
• External Data
– Federal and state government reports, industry association
reports, industry research reports etc.
Forecasting Methods: Regression/ multiple regression
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Domestic US Car Sales (DCS) Forecast

ACTUALS
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DCS Quarterly Forecast

Most recent quarters

Model through 2Q99
Forecast from 3Q99 to 2Q00

DCSF(t) = DCS(t-4)
Four period lag
1-29 Gap Sales Forecast
Naïve Model with 4 Quarter Lag
GapF(t) = Gap(t-4)
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Table 1-8
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