CHAPTER 4 FORECASTING CASH FLOWS: QUALITATIVE TECHNIQUES ANSWERS TO REVIEW QUESTIONS QUESTIONS 4.

1 Under what circumstances is the use of qualitative forecasting techniques appropriate? 4.2 Outline the steps involved in undertaking a survey to collect forecast estimates from individuals. Outline the advantages and disadvantages of using groups, as opposed to individuals, to provide forecasts. 4.3 What are the steps normally applied when undertaking a Delphi survey? What are some of the variants of this methods? 4.4 How is nominal group technique (NGT) different to the Delphi method? 4.5 Outline the jury of expert opinion method. How does this differ from the Delphi method? 4.6 A company offering eco-tourism adventures wishes to forecast the numbers of annual tourists of various types coming to a region five years from now, and chooses the Delphi method to develop their forecasts. (a) Explain how a panel of appropriate experts could be selected.

(b) Suggest how the information to the panel and questions could be framed. (c) How many rounds of data collection would you expect to undertake? Discuss how these would proceed.

4.7 The management of a coal-fired electricity generation station is concerned that new technology to reduce carbon dioxide emissions will be required to offset emissions, and measures such as purchase of carbon credits will be required if the national government signs up to the Kyoto protocol. The severity of adjustment for the company will depend on the extent of reduction in greenhouse-gas emissions agreed to by the national government. Explain how scenario forecasting could be used to aid decision making by the company. 4.8 A company engaged in sugar refining and export wishes to make medium term projections of international sugar prices. Suggest a method that could be used to make these forecasts.

ANSWERS Answer to Q 4.1 Qualitative techniques can be used in a wide range of circumstances. In some cases quantitative techniques cannot be used, e.g. when past information about the values being forecast does not exist. For example, for a new product, there are no past data on sales on which to base estimates of future sales. Similarly, past sales of a product might not be relevant if a competitor launches a new product with superior features or performance. In other situations, there is insufficient time to obtain data or use quantitative techniques, or circumstances are changing so rapidly that a statistically based forecast would be of little guidance. Even when statistical techniques are available qualitative techniques involving human judgement are often used by managers for forecasting. Further, managers appear to be more comfortable dealing with their own judgements or with those of a colleague, compared with forecasts generated via a computer package and lacking transparency. Even when quantitative techniques are used, estimates may be combined with qualitative judgements, or supplemented, reviewed or screened by subjecting them to qualitative judgements i.e. any forecasts provided by an analyst are for decision-support, not decision-making. It has been suggested that the widespread use of human judgement to make business forecasts can be rationalised in two ways. The first is that people might be better able to detect changing patterns in time series, which exhibit considerable random variations, compared with statistical models. The second rationale for the use of human judgement is that people might be able to integrate external (i.e. non-time series) information into the forecasting process. A number of qualitative forecasting techniques have been developed to provide estimates of key parameters for use in financial analysis in such situations. Answer to Q 4.2 The steps involved in undertaking a survey are outlined in Figure 4.1(of the book). It is important to note that the decisions made in the early stages affect the choices made in later stages. For example information needs specified at the start will affect the sampling design, the way in which the questionnaire is structured and the selection of data analysis techniques. These forward links in the survey process are indicated by solid arrows in Figure 4.1. It should be noted that if there were only forward links in the process then the conducting of a survey could be done one step at a time, completing each step before considering the next. Implicit in this single direction approach is the assumption that there are no limiting factors in later steps. This is seldom, if ever, the case. For instance there are often limitations on data collection or data processing resources, i.e. a budget constraint. These limitations restrict the alternatives available at earlier steps; these backward linkages are indicated in Figure 4.1 by dashed lines running upwards. Backward linkages run from the collect data and analyse data boxes back to the develop questionnaire and sample design phases. This illustrates that major decisions concerning data collection and analysis should always be considered before selecting a sample and designing a questionnaire.

Techniques for collecting information from individuals such as surveys and polls can be easy to implement, done at a low cost and on a timely basis. However evidence suggests that forecasts produced by groups offer greater forecasting accuracy than those derived from individuals. Groups also provide more information, although the marginal increase in information content decreases as group size increases. The use of groups also provides an opportunity to gain more information about the range of possible outcome values hence giving an insight into the risk associated with the estimates. From a behavioural perspective, it is also likely that a group responsible for a implementing a project will have greater commitment to it if they are also involved in providing estimates of variables used in the financial analysis leading up to a decision to proceed with a project. The choice between using individual versus group techniques really comes down to the particular situation and what is feasible. For instance group techniques such as Delphi and NGT often require greater skills, resources and time than collecting information from individuals using some form of survey or poll. Answer to Q 4.3 In a classic Delphi survey, the first round is unstructured, allowing panellists to identify freely and elaborate on the issues that they consider important. These are then consolidated into a single set by the monitors, who then produce a structured questionnaire designed to elicit the views, opinions and judgements of the panellists in a quantitative form. The consolidated list of scenarios is presented to the panellists in round two, at which time they place estimates on key variables such as the time an event will occur. These responses are then summarised and the summary information is presented to the panellists, who are invited to reassess their original opinions in light of anonymous individual responses. In addition, if panellists assessments fall outside the upper or lower quartiles, they may be asked to provide justifications as to why they consider their estimates are more accurate than the median values. Further rounds of collection of estimates, compiling summary information and inviting revisions continues until there is no further convergence of expert opinion. Experience reveals this usually occurs after two rounds, or at the most four rounds (Janssen 1978). There are a number of variants on the classical Delphi method. When the issues are well defined, a clearly defined scenario can be developed by the monitoring team. In such circumstances, it is common to replace the unstructured first round with a highly structured set of questions through which specific estimates of parameters are obtained. A statistical summary of all responses is then provided to the panel for the second round, rather than in the third. In such cases, it is common for the Delphi method to include only one or two iterations. Another variant is the paper Delphi (sometimes also known as a paper and pencil Delphi poll) that is conducted entirely by mail. Another variant is the real time Delphi whereby feedback is provided by computer and final results are usually available at the end of the session. Answer to Q 4.4

The classic Delphi method is conducted through a combination of a polling procedure and a conference. Communication between conference panellists is however restricted and undertaken through the monitoring team. Even though panellists are at the same physical location, there is no face-to-face contact. Even in variants of the Delphi, there is no face-to-face contact. The nominal group technique (NGT) uses the basic Delphi structure but in face-to-face meetings which allow discussion among participants. A meeting with NGT starts without any interaction, with individuals initially writing down ideas or estimates related to the problem or scenario. Each individual then presents their ideas or estimates, with no discussion until all participants have spoken. Then each idea or estimate is discussed. The process is then repeated. For this reason, NGT is sometimes known as the estimate-talk-estimate procedure. In practical terms, like Delphi, the framing of the questions or the scenario is crucial for the success of the process. Also, ideally, the leader or moderator of the discussion should come from outside the group. Answer to Q 4.5 The jury of expert opinion is one of the simplest and most widely used forecasting approaches. In its most basic form it involves simply executives meeting and deciding on the best estimate for the item being forecast. As a precursor to the meeting, it is common to provide background information to executives. There are a number of variants of this technique discussed in Chapter 4. One of these variants is when the estimates of the group are obtained by participants writing their estimates on paper, and then combined to produce an average. This variant of the jury of expert opinion approach could almost be considered an informal variant of the Delphi method. The key difference is that there is no mechanism to prevent interaction amongst group members. Answer to Q 4.6 (a) The criteria for selecting panel members should be determined at the start of the exercise. In this case, the criteria may be that the person has a minimum number of years of experience in (or knowledge of) the tourism industry in the region and be in a senior or management position in which they are exposed to changing trends in tourist activity. In this case, the issues are likely to be fairly well defined and a clearly developed scenario involving the future tourist industry could be developed which sought specific estimates of future tourist numbers in five years. As such, the unstructured first round of the traditional Delphi might be replaced with a structured set of questions through which specific estimates of future tourist numbers could be obtained. For example, the Delphi could be framed to present the main tourist types and then ask the panelists to estimate the likely number of tourists of each group coming to the region in five years time. Alternatively, if a traditional Delphi is used, in the first round panelists may be asked to identify the key factors influencing tourist numbers coming to the region. For instance, respondents might identify that the exchange rate has a major impact on the

(b)

number of international tourists, and that the backpacker numbers are more sensitive to these fluctuations compared with the international retiree market numbers. Based on this response from the first round, in the second round, a specific question might be framed asking what the likely impact on numbers of backpacker and retiree respectively if the exchange rate became more or less favourable. (c) The number of rounds will depend on the panelists and the manner in which the Delphi is conducted, i.e. at what stage the structured questionnaire is distributed. If the survey was simply asking for estimates of likely tourist numbers in five years and these were relatively easy to predict based on past experience then it would be likely that estimates from respondents would conver after only one or two rounds of the structured survey. The greater the degree of uncertainty, the more rounds that will be needed to reach some degree of convergence, or at least reach a stage where panelists are not changing their estimates in response to the feedback provided. Typically few Delphi surveys however go past two iterations.

Answer to Q 4.7 Scenario forecasting could be used in a number of ways in helping the decision making of the company. For instance, the company could develop three scenarios a best case, most likely and worst case and assess the likely impact of these. The best case scenario might be that the no carbon dioxide reductions will be agreed to by the national government and hence no new technology to reduce carbon emissions will be needed except to the extent that it would have been replaced with more efficient technology as part of the normal course of operations. The most likely scenario might be that the national government accepts relatively modest targets for reducing carbon dioxide emissions by a widely accepted figure of say 5%. The worst case scenario might be that government targets the electricity industry which results in targets set for reducing emissions being highly onerous and requiring the company to reduce emissions to 80% of current levels. Once management identified each of these scenarios, they could then use these to identify strategies for complying with the emission requirements and what the likely cost of these would be. The steps in developing these scenarios would follow the steps set out in Chapter 4. Answer to Q 4.8 Many of the methods outlined in Chapter 4 could be used to forecast medium term international sugar prices. In fact, it is also possible that one of the quantitative forecasting methods regression analysis - discussed in Chapter 3 could also be applied, if the past trend is likely to be repeated in the future. Which method is most appropriate ultimately comes down to what level of accuracy in the forecast is required, the amount of resources available to obtain the forecast and the timeframe in which the forecast must be obtained. For instance, if accuracy is of paramount importance and cost not a major consideration, then the NGT would probably be the favoured technique. However bringing groups of experts together for a face-to-face meeting as is

required for NGT or classic Delphi, may be both difficult and expensive. In such cases, a postal Delphi may be the most appropriate technique to use. Staticized group techniques are often even simpler and less costly to apply and may be considered if the trade-off with slightly reduced accuracy is thought appropriate. Staticized group estimates can also be compiled quickly if necessary and may be considered when estimates are needed quickly. Furthermore, when there is the potential for major or discrete changes, the use of scenarios is a technique that provides a convenient framework for assessing the potential impact of these. No matter what technique is selected, it is important to recognise the limitations of the technique as these will impact on how the technique is applied and the quality of the forecasts obtained. Furthermore, with any technique that involves the collection of data it is essential to proceed in an orderly and well thought-out manner. Sometimes there is a tendency to collect information first and then worry about how it is to be used. The starting point however should be first to clearly identify what information is needed, decide on the most appropriate technique to collect the data (in context of the resources, time and other limitations) and only then commence collection.