17 Forecasting and Decision Making

Dr.Shafali Nagpal

17.1  Learning Objective

17.2  Introduction

17.3  Meaning of Forecasting

17.4  Concept and Purpose of Forecasting

17.5  Qualitative Techniques

17.6  Steps in Forecasting

17.7 Decision Making and Steps of Decision making

17.8 Summary

Learning Objectives

After completing this module, you will be able to:

1.  To understand forecasting

2. To understand forecasting and decision making

3. To know the relationship between forecasting and decision making

Introduction

The successful businesses of the future are being created today by individuals and teams in tune with fast‐moving technologies, new markets and changing lifestyles. New disciplines have sprung up, new professions are born and new skills are in demand. There is a need to blend the new skills with those of the older professions. Many business decisions involve forecasting. In recent years its scope has expanded well beyond technical aspects. Addresses a broader set of managerial concerns through down‐to‐earth descriptions of forecasting, its advantages and limitations, and its role in the managerial decision‐making process.

Forecasting techniques can be helpful to organizations planning for their future. Of the many techniques available, only a few are needed in the process of corporate strategic planning. Other methods of forecasting may be useful for other more specialized functions within the organization.

Meaning of Forecasting:

In preparing plans for the future, the management authority has to make some predictions about what is likely to happen in the future. It shows that the managers know something of future happenings even before things actually happen. Forecasting provides them this knowledge. Forecasting is the process of estimating the relevant events of future, based on the analysis of their past and present behaviour.

The future cannot be probed unless one knows how the events have occurred in the past and how they are occurring presently. The past and present analysis of events provides the base helpful for collecting information about their future occurrence. Thus, forecasting may be defined as the process of assessing the future normally using calculations and projections that take account of the past performance, current trends, and anticipated changes in the foreseeable period ahead. Whenever the managers plan business operations and organisational set-up for the years ahead, they have to take into account the past, the present and the prevailing economic, political and social conditions. Forecasting provides a logical basis for determining in advance the nature of future business operations and the basis for managerial decisions about the material, personnel and other requirements.

It is, thus, the basis of planning, when a business enterprise makes an attempt to look into the future in a systematic and concentrated way, it may discover certain aspects of its operations requiring special attention. However, it must be recognised that the process of forecasting involves an element of guesswork and the managers cannot stay satisfied and relaxed after having prepared a forecast.

Concept

A manager generally assumes that when asking a forecaster to prepare a specific projection, the request itself provides sufficient information for the forecaster to go to work and do the job. This is almost never true. Successful forecasting begins with a collaboration between the manager and the forecaster, in which they work out answers to the following questions.

What is the purpose of the forecast—how is it to be used?

This determines the accuracy and power required of the techniques, and hence governs selection. Deciding whether to enter a business may require only a rather gross estimate of the size of the market, whereas a forecast made for budgeting purposes should be quite accurate. The appropriate techniques differ accordingly. Again, if the forecast is to set a “standard” against which to evaluate performance, the forecasting method should not take into account special actions, such as promotions and other marketing devices, since these are meant to change historical patterns and relationships and hence form part of the “performance” to be evaluated.

Forecasts that simply sketch what the future will be like if a company makes no significant changes in tactics and strategy are usually not good enough for planning purposes. On the other hand, if management wants a forecast of the effect that a certain marketing strategy under debate will have on sales growth, then the technique must be sophisticated enough to take explicit account of the special actions and events the strategy entails. Techniques vary in their costs, as well as in scope and accuracy. The manager must fix the level of inaccuracy he or she can tolerate—in other words, decide how his or her decision will vary, depending on the range of accuracy of the forecast. This allows the forecaster to trade off cost against the value of accuracy in choosing a technique.

For example, in production and inventory control, increased accuracy is likely to lead to lower safety stocks. Here the manager and forecaster must weigh the cost of a more sophisticated and more expensive technique against potential savings in inventory costs.

What are the dynamics and components of the system for which the forecast will be made?

This clarifies the relationships of interacting variables. Generally, the manager and the forecaster must review a flow chart that shows the relative positions of the different elements of the distribution system, sales system, production system, or whatever is being studied.

How important is the past in estimating the future

Significant changes in the system—new products, new competitive strategies, and so forth— diminish the similarity of past and future. Over the short term, recent changes are unlikely to cause overall patterns to alter, but over the long term their effects are likely to increase. The executive and the forecaster must discuss these fully.

Qualitative techniques

Primarily, these are used when data are scarce—for example, when a product is first introduced into a market. They use human judgment and rating schemes to turn qualitative information into quantitative estimates.

The objective here is to bring together in a logical, unbiased, and systematic way all information and judgments which relate to the factors being estimated. Such techniques are frequently used in new-technology areas, where development of a product idea may require several “inventions,” so that R&D demands are difficult to estimate, and where market acceptance and penetration rates are highly uncertain. “Basic Forecasting Techniques” presents several examples of this type, including market research and Delphi technique1which now popular.

Time series analysis

These are statistical techniques used when several years’ data for a product or product line are available and when relationships and trends are both clear and relatively stable.

One of the basic principles of statistical forecasting—indeed, of all forecasting when historical data are available—is that the forecaster should use the data on past performance to get a “speedometer reading” of the current rate (of sales, say) and of how fast this rate is increasing or decreasing. The current rate and changes in the rate—“acceleration” and “deceleration”— constitute the basis of forecasting. Once they are known, various mathematical techniques can develop projections from them. The matter is not so simple as it sounds, however. It is usually difficult to make projections from raw data since the rates and trends are not immediately obvious; they are mixed up with seasonal variations, for example, and perhaps distorted by such factors as the effects of a large sales promotion campaign. The raw data must be massaged before they are usable, and this is frequently done by time series analysis.

Now, a time series is a set of chronologically ordered points of raw data—for example, a division’s sales of a given product, by month, for several years. Time series analysis helps to identify and explain:

• Any regularity or systematic variation in the series of data which is due to seasonality— the “seasonals.”
• Cyclical patterns that repeat any two or three years or more.
• Trends in the data.
• Growth rates of these trends.

(Unfortunately, most existing methods identify only the seasonals, the combined effect of trends and cycles, and the irregular, or chance, component. That is, they do not separate trends from cycles. We shall return to this point when we discuss time series analysis in the final stages of product maturity.)

Causal models

When historical data are available and enough analysis has been performed to spell out explicitly the relationships between the factor to be forecast and other factors (such as related businesses, economic forces, and socioeconomic factors), the forecaster often constructs a causal model. A causal model is the most sophisticated kind of forecasting tool. It expresses mathematically the relevant causal relationships, and may include pipeline considerations (i.e., inventories) and market survey information. It may also directly incorporate the results of a time series analysis.

The causal model takes into account everything known of the dynamics of the flow system and utilizes predictions of related events such as competitive actions, strikes, and promotions. If the data are available, the model generally includes factors for each location in the flow chart and connects these by equations to describe overall product flow. If certain kinds of data are lacking, initially it may be necessary to make assumptions about some of the relationships and then track what is happening to determine if the assumptions are true. Typically, a causal model is continually revised as more knowledge about the system becomes available.

Role of Forecasting:

Since planning involves the future, no usable plan can be made unless the manager is able to take all possible future events into account. This explains why forecasting is a critical element in the planning process. In fact, every decision in the organisation is based on some sort of forecasting.

It helps the managers in the following ways:

1. Basis of Planning:

Forecasting is the key to planning. It generates the planning process. Planning decides the future course of action which is expected to take place in certain circumstances and conditions. Unless the managers know these conditions, they cannot go for effective planning.

Forecasting provides the knowledge of planning premises within which the managers can analyse their strengths and weaknesses and can take appropriate actions in advance before actually they are put out of market. Forecasting provides the knowledge about the nature of future conditions.

2. Promotion of Organization:

The objectives of an organisation are achieved through the performance of certain activities. What activities should be performed depends on the expected outcome of these activities. Since expected outcome depends on future events and the way of performing various activities, forecasting of future events is of direct relevance in achieving an objective.

3. Facilitating Co-ordination and Control:

Forecasting indirectly provides the way for effective co-ordination and control. Forecasting requires information about various factors. Information is collected from various internal and external sources. Almost all units of the organisation are involved in this process.

It provides interactive opportunities for better unity and co-ordination in the planning process. Similarly, forecasting can provide relevant information for exercising control. The managers can know their weaknesses in the forecasting process and they can take suitable action to overcome these.

4. Success in Organisation:

All business enterprises are characterised by risk and have to work within the ups and downs of the industry. The risk depends on the future happenings and forecasting provides help to overcome the problem of uncertainties. Though forecasting cannot check the future happenings, it provides clues about those and indicates when the alternative actions should be taken. Managers can save their business and face the unfortunate happenings if they know in advance what is going to happen.

Steps in Forecasting:

The process of forecasting generally involves the following steps:

1. Developing the Basis:

The future estimates of various business operations will have to be based on the results obtainable through systematic investigation of the economy, products and industry.

2. Estimation of Future Operations:

On the basis of the data collected through systematic investigation into the economy and industry situation, the manager has to prepare quantitative estimates of the future scale of business operations. Here the managers will have to take into account the planning premises.

3. Regulation of Forecasts:

It has already been indicated that the managers cannot take it easy after they have formulated a business forecast. They have to constantly compare the actual operations with the forecasts prepared in order to find out the reasons for any deviations from forecasts. This helps in making more realistic forecasts for future.

4. Review of the Forecasting Process:

Having determined the deviations of the actual performances from the positions forecast by the managers, it will be necessary to examine the procedures adopted for the purpose so that improvements can be made in the method of forecasting.

Decision-Making

The word ‘decides’ means to come to a conclusion or resolution as to what one is expected to do at some later time. According to Manely H. Jones, “It is a solution selected after examining several alternatives chosen because the decider foresees that the course of action he selects will do more than the others to further his goals and will be accompanied by the fewest possible objectionable consequences”. Decision is a choice whereby a person comes to a conclusion about given circumstances/ situation. It represents a course of behaviour or action about what one is expected to do or not to do. Decision- making may, therefore, be defined as a selection of one course of action from two or more alternative courses of action. Thus, it involves a choice-making activity and the choice determines our action or inaction.

Decision-making is an indispensable part of life. Innumerable decisions are taken by human beings in day-to-day life. In business undertakings, decisions are taken at every step. All managerial functions viz., planning, organizing, staffing, directing, coordinating and controlling are carried through decisions. Decision-making is thus the core of managerial activities in an organisation.

Steps Involved In Decision Making Process

Decision-making involves a number of steps which need to be taken in a logical manner. This is treated as a rational or scientific ‘decision-making process’ which is lengthy and time consuming. Such lengthy process needs to be followed in order to take rational/scientific/result oriented decisions. Decision-making process prescribes some rules and guidelines as to how a decision should be taken / made. This involves many steps logically arranged. It was Peter Drucker who first strongly advocated the scientific method of decision-making in his world famous book ‘The Practice of Management’ published in 1955. Drucker recommended the scientific method of decision-making which, according to him, involves the following six steps:

1.      Defining / Identifying the managerial problem,

2.      Analyzing the problem,

3.      Collecting Data

4.      Developing alternative solutions,

5.      Selecting the best solution out of the available alternatives,

6.      Converting the decision into action, and

7.      Ensuring feedback for follow-up.

1. Identifying the Problem: Identification of the real problem before a business enterprise is the first step in the process of decision-making. It is rightly said that a problem well-defined is a problem half-solved. Information relevant to the problem should be gathered so that critical analysis of the problem is possible. This is how the problem can be diagnosed. Clear distinction should be made between the problem and the symptoms which may cloud the real issue. In brief, the manager should search the ‘critical factor’ at work. It is the point at which the choice applies. Similarly, while diagnosing the real problem the manager should consider causes and find out whether they are controllable or uncontrollable.
2. Analyzing the Problem: After defining the problem, the next step in the decision-making process is to analyze the problem in depth. This is necessary to classify the problem in order to know who must take the decision and who must be informed about the decision taken. Here, the following four factors should be kept in mind:

1. Futurity of the decision,
2. The scope of its impact,
3. Number of qualitative considerations involved, and
4. Uniqueness of the decision.
5. Collecting Relevant Data: After defining the problem and analyzing its nature, the next step is to obtain the relevant information/ data about it. There is information flood in the business world due to new developments in the field of information technology. All available information should be utilised fully for analysis of the problem. This brings clarity to all aspects of the problem.
6. Developing Alternative Solutions: After the problem has been defined, diagnosed on the basis of relevant information, the manager has to determine available alternative courses of action that could be used to solve the problem at hand. Only realistic alternatives should be considered. It is equally important to take into account time and cost constraints and psychological barriers that will restrict that number of alternatives. If necessary, group participation techniques may be used while developing alternative solutions as depending on one solution is undesirable.
7. Selecting the Best Solution: After preparing alternative solutions, the next step in the decision-making process is to select an alternative that seems to be most rational for solving the problem. The alternative thus selected must be communicated to those who are likely to be affected by it. Acceptance of the decision by group members is always desirable and useful for its effective implementation.
8. Converting Decision into Action: After the selection of the best decision, the next step is to convert the selected decision into an effective action. Without such action, the decision will remain merely a declaration of good intentions. Here, the manager has to convert ‘his decision into ‘their decision’ through his leadership. For this, the subordinates should be taken in confidence and they should be convinced about the correctness of the decision. Thereafter, the manager has to take follow-up steps for the execution of decision taken.
9. Ensuring Feedback: Feedback is the last step in the decision-making process. Here, the manager has to make built-in arrangements to ensure feedback for continuously testing actual developments against the expectations. It is like checking the effectiveness of follow-up measures. Feedback is possible in the form of organised information, reports and personal observations. Feed back is necessary to decide whether the decision already taken should be continued or be modified in the light of changed conditions.

Summary

Decision making is a vital skill in the business workplace, particularly for managers and those in leadership positions. Following a logical procedure like the one outlined here, along with being aware of common challenges, can help ensure both thoughtful decision making and positive results.

References

• McGregor, 2010 McGregor, L. 2010, Improving the quality and speed of decision making, Journal of change management, pages 344-356.
• Nazeri, A. et al, 2011, The Effect of Quality Management and Participative Decision-making on Individual Performance, International Conference on Information Communication and Management.
• Kootnz & O’Donnell, Principles of Management.
• J.S. Chandan, Management Concepts and Strategies.
• Stephen P Robbins, David A Decanzo, Fundamentals of Management, 3rd Edition, Pearson Education, 2002.
• Kotler, P. (1991). Marketing Management. 7th ed. Prentice-Hall
• David, F.R. (2009). Strategic Management: Concepts and Cases. 12th ed. FT Prentice Hall.