Judgemental forecasting ppt

Statistics, Data Analysis, and Decision Modeling

FOURTH EDITION

James R. Evans

9780558689766

Chapter 7 Forecasting

Introduction

QUALITATIVE AND JUDGMENTAL METHODS

Historical Analogy

The Delphi Method

Indicators and Indexes for Forecasting

STATISTICAL FORECASTING MODELS

FORECASTING MODELS FOR STATIONARY TIME SERIES

Moving Average Models

Error Metrics and Forecast Accuracy

Exponential Smoothing Models

FORECASTING MODELS FOR TIME SERIES WITH TREND AND SEASONALITY

Models for Linear Trends

Models for Seasonality

Models for Trend and Seasonality

CHOOSING AND OPTIMIZING FORECASTING MODELS USING CB PREDICTOR

REGRESSION MODELS FOR FORECASTING

Autoregressive Forecasting Models

Incorporating Seasonality in Regression Models

Regression Forecasting with Causal Variables

THE PRACTICE OF FORECASTING

BASIC CONCEPTS REVIEW QUESTIONS

SKILL-BUILDING EXERCISES

SKILL-BUILDING EXERCISES

PROBLEMS AND APPLICATIONS

CASE: ENERGY FORECASTING

APPENDIX: ADVANCED FORECASTING MODELS—THEORY AND COMPUTATION

Double Moving Average

Double Exponential Smoothing

Additive Seasonality

Multiplicative Seasonality

Holt–Winters Additive Model

Holt– –Winters Multiplicative Model

INTRODUCTION

One of the major problems that managers face is forecasting future events in order to make good decisions. For example, forecasts of interest rates, energy prices, and other economic indicators are needed for financial planning; sales forecasts are needed to plan production and workforce capacity; and forecasts of trends in demographics, consumer behavior, and technological innovation are needed for long-term strategic planning. The government also invests significant resources on predicting short-run U.S. business performance using the Index of Leading Indicators. This index focuses on the performance of individual businesses, which often is highly correlated with the performance of the overall economy, and is used to forecast economic trends for the nation as a whole. In this chapter, we introduce some common methods and approaches to forecasting, including both qualitative and quantitative techniques.

Managers may choose from a wide range of forecasting techniques. Selecting the appropriate method depends on the characteristics of the forecasting problem, such as the time horizon of the variable being forecast, as well as available information on which the forecast will be based. Three major categories of forecasting approaches are qualitative and judgmental techniques, statistical time-series models, and explanatory/causal methods.

Qualitative and judgmental techniques rely on experience and intuition; they are necessary when historical data are not available or when the decision maker needs to forecast far into the future. For example, a forecast of when the next generation of a microprocessor will be available and what capabilities it might have will depend greatly on the opinions and expertise of individuals who understand the technology.

Statistical time-series models find greater applicability for short-range forecasting problems. A time series is a stream of historical data, such as weekly sales. Time-series models assume that whatever forces have influenced sales in the recent past will continue into the near future; thus, forecasts are developed by extrapolating these data into the future.

Explanatory/causal models seek to identify factors that explain statistically the patterns observed in the variable being forecast, usually with regression analysis. While time-series models use only time as the independent variable, explanatory/causal models generally include other factors. For example, forecasting the price of oil might incorporate independent variables such as the demand for oil (measured in barrels), the proportion of oil stock generated by OPEC countries, and tax rates. Although we can never prove that changes in these variables actually cause changes in the price of oil, we often have evidence that a strong influence exists.

Surveys of forecasting practices have shown that both judgmental and quantitative methods are used for forecasting sales of product lines or product families, as well as for broad company and industry forecasts. Simple time-series models are used for short- and medium-range forecasts, whereas regression analysis is the most popular method for long-range forecasting. However, many companies rely on judgmental methods far more than quantitative methods, and almost half judgmentally adjust quantitative forecasts.

In this chapter, we focus on these three approaches to forecasting. Specifically, we will discuss the following:

Historical analogy and the Delphi method as approaches to judgmental forecasting

Moving average and exponential smoothing models for time-series forecasting, with a discussion of evaluating the quality of forecasts

A brief discussion of advanced time-series models and the use of Crystal Ball (CB) Predictor for optimizing forecasts

The use of regression models for explanatory/causal forecasting

Some insights into practical issues associated with forecasting

Qualitative and Judgmental Methods

Qualitative, or judgmental, forecasting methods are valuable in situations for which no historical data are available or for those that specifically require human expertise and knowledge. One example might be identifying future opportunities and threats as part of a SWOT (Strengths, Weaknesses, Opportunities, and Threats) analysis within a strategic planning exercise. Another use of judgmental methods is to incorporate nonquantitative information, such as the impact of government regulations or competitor behavior, in a quantitative forecast. Judgmental techniques range from such simple methods as a manager’s opinion or a group-based jury of executive opinion to more structured approaches such as historical analogy and the Delphi method.

Historical Analogy

One judgmental approach is historical analogy, in which a forecast is obtained through a comparative analysis with a previous situation. For example, if a new product is being introduced, the response of similar previous products to marketing campaigns can be used as a basis to predict how the new marketing campaign might fare. Of course, temporal changes or other unique factors might not be fully considered in such an approach. However, a great deal of insight can often be gained through an analysis of past experiences. For example, in early 1998, the price of oil was about $22 a barrel. However, in mid-1998, the price of a barrel of oil dropped to around $11. The reasons for this price drop included an oversupply of oil from new production in the Caspian Sea region, high production in non-OPEC regions, and lower-than-normal demand. In similar circumstances in the past, OPEC would meet and take action to raise the price of oil. Thus, from historical analogy, we might forecast a rise in the price of oil. OPEC members did in fact meet in mid-1998 and agreed to cut their production, but nobody believed that they would actually cooperate effectively, and the price continued to drop for a time. Subsequently, in 2000, the price of oil rose dramatically, falling again in late 2001. Analogies often provide good forecasts, but you need to be careful to recognize new or different circumstances. Another analogy is international conflict relative to the price of oil. Should war break out, the price would be expected to rise, analogous to what it has done in the past.

The Delphi Method

A popular judgmental forecasting approach, called the Delphi method, uses a panel of experts, whose identities are typically kept confidential from one another, to respond to a sequence of questionnaires. After each round of responses, individual opinions, edited to ensure anonymity, are shared, allowing each to see what the other experts think. Seeing other experts’ opinions helps to reinforce those in agreement and to influence those who did not agree to possibly consider other factors. In the next round, the experts revise their estimates, and the process is repeated, usually for no more than two or three rounds. The Delphi method promotes unbiased exchanges of ideas and discussion and usually results in some convergence of opinion. It is one of the better approaches to forecasting long-range trends and impacts.

Indicators and Indexes for Forecasting

Bottom of Form

Indicators and indexes generally play an important role in developing judgmental forecasts. Indicators are measures that are believed to influence the behavior of a variable we wish to forecast. By monitoring changes in indicators, we expect to gain insight about the future behavior of the variable to help forecast the future. For example, one variable that is important to the nation’s economy is the Gross Domestic Product (GDP), which is a measure of the value of all goods and services produced in the United States. Despite its shortcomings (for instance, unpaid work such as housekeeping and child care is not measured; production of poor-quality output inflates the measure, as does work expended on corrective action), it is a practical and useful measure of economic performance. Like most time series, the GDP rises and falls in a cyclical fashion. Predicting future trends in the GDP is often done by analyzing leading indicators—series that tend to rise and fall some predictable length of time prior to the peaks and valleys of the GDP. One example of a leading indicator is the formation of business enterprises; as the rate of new businesses grows, one would expect the GDP to increase in the future. Other examples of leading indicators are the percent change in the money supply (M1) and net change in business loans. Other indicators, called lagging indicators, tend to have peaks and valleys that follow those of the GDP. Some lagging indicators are the Consumer Price Index, prime rate, business investment expenditures, or inventories on hand. The GDP can be used to predict future trends in these indicators.

Indicators are often combined quantitatively into an index. The direction of movement of all the selected indicators are weighted and combined, providing an index of overall expectation. For example, financial analysts use the Dow Jones Industrial Average as an index of general stock market performance. Indexes do not provide a complete forecast, but rather a better picture of direction of change, and thus play an important role in judgmental forecasting.

The Department of Commerce began an Index of Leading Indicators to help predict future economic performance. Components of the index include the following: