What you can or cannot forecast
Forecasting is required in many situations: deciding whether to build another power generation plant in the next five years requires forecasts of future demand; scheduling staff in a call centre next week requires forecasts of call volumes; stocking an inventory requires forecasts of stock requirements. Forecasts can be required several years in advance (for the case of capital investments), or only a few minutes beforehand (for telecommunication routing). Whatever the circumstances or time horizons involved, forecasting is an important aid to effective and efficient planning.
Some things are easier to forecast than others. The time of the sunrise tomorrow morning can be forecast precisely. On the other hand, tomorrow’s lotto numbers cannot be forecast with any accuracy. The predictability of an event or a quantity depends on several factors including:
- how well we understand the factors that contribute to it;
- how much data is available;
- what data is available;
- whether the forecasts can affect the thing we are trying to forecast.
For example, forecasts of electricity demand can be highly accurate because all conditions are usually satisfied. We have a good idea of the contributing factors: electricity demand is driven largely by temperatures, with smaller effects for calendar variation such as holidays, and economic conditions. Provided there is a sufficient history of data on electricity demand and weather conditions, and we have the skills to develop a good model linking electricity demand and the key driver variables, the forecasts can be remarkably accurate.