RETAIL GLOSSARY

# Causal Forecasting

A demand forecasting method that considers external factors, such as economic indicators, promotions, or events, which may influence customer demand.

## What is Causal Forecasting?

Causal Forecasting is a method that analyses the relationship between variables to predict future outcomes. It identifies cause-and-effect relationships and uses historical data to develop a model for forecasting. The process involves identifying causal factors, analysing data, developing a model, and validating the forecasts. Causal Forecasting improves accuracy by considering the factors that influence the dependent variable.

## How Causal Forecasting works

• Identification of causal factors: The first step in Causal Forecasting is identifying the factors that influence the variable of interest. These factors can be internal or external to the system being analysed.

• Data analysis: Historical data is collected for both the dependent variable (the variable to be forecasted) and the independent variables (the causal factors). The data is analysed to determine the relationships between the variables.

• Model development: Based on the analysis, a statistical model is developed to represent the relationships between the variables. This model can take various forms, such as regression models, time series models, or other mathematical models.

• Forecasting: Once the model is developed, it can be used to forecast future values of the dependent variable. By inputting values of the independent variables into the model, predictions can be generated for the variable of interest.

• Validation: The forecasts generated by the model are compared to actual data to assess the accuracy and reliability of the forecasts. Adjustments and refinements to the model may be made based on the validation results.
Causal Forecasting takes into account the causal factors that influence the variable being forecasted, providing a more accurate and insightful prediction compared to other forecasting methods.

## Pros of Causal Forecasting

1. Accurate predictions: Causal Forecasting considers the cause-and-effect relationships between variables, allowing for more accurate predictions. By incorporating the impact of causal factors, it captures the underlying dynamics and can better account for fluctuations and changes in the variables being forecasted.
2. Insightful analysis: Causal Forecasting provides valuable insights into the relationships between variables. It helps identify the key drivers that influence the variable of interest, allowing businesses to understand the factors that impact their outcomes. This information can be used to make informed decisions, develop effective strategies, and optimise operations.
3. Scenario analysis and decision-making: Causal Forecasting enables scenario analysis, where different scenarios can be simulated by manipulating the causal factors. This helps businesses evaluate the potential outcomes of different strategies or interventions before implementing them. It supports data-driven decision-making and allows for proactive planning and risk management.

## Cons of Causal Forecasting

1. Data requirements: Causal Forecasting relies on historical data for both the variable of interest and the causal factors. Obtaining accurate and reliable data can be challenging, especially when dealing with complex relationships and multiple variables. Data collection and preparation can be time-consuming and require expertise in data analysis.
2. Assumptions and limitations: Causal Forecasting assumes that the relationships between variables remain stable over time. However, in dynamic and complex business environments, these relationships can change due to various factors such as market trends, consumer behaviour, or external events. Inaccurate assumptions or overlooking critical variables can lead to unreliable forecasts.
3. Complexity and model selection: Causal Forecasting involves selecting appropriate models and determining the appropriate causal factors to include. Choosing the right model and identifying the correct causal factors can be complex, especially when dealing with large datasets and numerous potential variables. It requires expertise in statistical analysis and domain knowledge to ensure accurate and meaningful results.

## FAQ

Below you will find answers to common questions
How can Causal Forecasting help my business improve inventory management?
Causal Forecasting can help your business improve inventory management by identifying the causal factors that influence demand for your products. By analysing historical data and considering external factors such as promotions, marketing campaigns, and economic indicators, Causal Forecasting can provide insights into the drivers of demand. This information allows you to adjust your inventory levels accordingly, ensuring that you have the right amount of stock available to meet customer demand while minimising excess inventory and associated costs.
What are the key considerations when implementing Causal Forecasting in my business?
When implementing Causal Forecasting in your business, there are a few key considerations to keep in mind. First, ensure that you have access to reliable and relevant historical data for both the variable of interest (e.g., sales) and the potential causal factors (e.g., price, promotions, weather). Quality data is essential for accurate forecasting results. Second, carefully select the causal factors to include in your analysis based on their relevance and influence on the variable of interest. Conducting thorough data analysis and considering domain expertise can help in identifying the most impactful factors. Finally, regularly evaluate and update your models as business conditions change and new data becomes available. Continuous monitoring and refinement of the forecasting process can help maintain accuracy and relevance in your forecasts.