The Business Forecasting Deal - Exposing bad practices in business forecasting... and providing practical solutions

Aren’t the internets wonderful? Just today I was trying to find the antonym of “naïve” and came across several terrific choices (sophisticated, worldly, well-informed, and intelligent) and one that didn’t make any sense (svelte???). However, upon further review at Merriam-Webster.com, I discovered that in addition to slender, lithe, and sleek (the definitions I expected), svelte could also mean urbane or suave. So a person could actually be svelte and obese at the same time. I never would have known that – thank you Al Gore!

In real life, it is probably a good thing to be informed, skeptical, and difficult to be taken advantage of. In short, it is good to be svelte. This applies to your (hopefully limited) encounters with strange men at highway rest stops, as much as it does to your (hopefully even more limited) encounters with forecasting software vendors.

Despite my plea that you remain svelte in real life, I implore you to be naïve in business forecasting – and use a naïve forecasting model early and often. A naïve forecasting model is the most important model you will ever use in business forecasting. It should also be the worst forecasting model you will ever use – but probably won’t be. Let me explain…

Per the standard forecasting text, naïve forecasts are “Forecasts obtained with the minimal amount of effort and data manipulation and based solely on the most recent information available.” An important characteristic of a naïve forecasting model is that it can be easily automated and produced at virtually no cost -- without the need for forecasters or forecasting software. This is important because it sets a baseline for performance. If you can achieve X% error using a naïve model, then you sure as heck better be able to achieve less than X% error with whatever people and process and technology you are using to forecast. This is the fundamental idea behind Forecast Value Added Analysis, where you compare all forecasting process activities to “doing nothing” and eliminate those activities that aren’t making the forecast any better.

Purists may argue that the only true naïve forecast is the “no-change” forecast, meaning either a random walk (forecast = last known actual) or a seasonal random walk (e.g. forecast = actual from corresponding period last year). These are referred to as NF1 and NF2 in the Makridakis text (where NF = Naïve Forecast). In our 2006 SAS webseries Finding Flaws in Forecasting, an attendee asked “What about using a simple time series forecast with no intervention as the naïve forecast?” Is that allowed?

Our purpose is to determine whether all our elaborate forecasting systems and processes are adding value by making the forecast better. For this objective, it is perfectly acceptable to use something more sophisticated than a random walk as another point of comparison in the FVA analysis. A thorough FVA analysis evaluates the performance of every step and participant in the forecasting process. If you have forecasting software that will automatically generate forecasts for you (essentially for “free” once you have licensed and installed the software), it is important to know whether that system generated forecast is any better than NF1 or NF2. The key is comparing costly and heroic forecasting efforts to forecasts created by doing the minimum amount of work. Does the extra cost and effort make a meaningful improvement in the forecast? If not, then the cost and effort probably aren’t worth it.

I personally won’t report you to the forecasting police if you do use something a bit more sophisticated than NF1 or NF2 as your naïve model. A moving average or simple exponential smoothing are suitable choices. However, I will report you for failing to do the appropriate comparisons – and you know what happens then.