DEMAND FORECASTING

Meaning of demand forecasting

            Future is unknown and uncertain. However, managers have to make plans for future levels of production in the present. It always takes time for building up productive capacity to produce a product. Machines have to be ordered and installed, the required skilled labor has to be employed and trained, funds have to be arranged for fund production. If the future demand for the product is not known in advance proper planning for future production cannot be done. Thus, managers have to operate in uncertain environment. To reduce this uncertainty in planning for future production levels demand forecasting is essential. Forecasting demand means prediction of future demand. Forecasting of future demand is one of the most importance functions of managers of firms. Good forecasting of demand, reduces uncertainty of environment in which business decisions are made. If the future was known with certainty of would not be required. If there is a certainty about future demand, decision about proper level of production could be taken on a once-for-all basis and no revision of it would be required. However, uncertainty is a fact of life and, therefore, a good forecast of future demand is necessary if proper planning for future level of production is to be made.

            Good forecasting of future demand is also important for calculating rate of return on capital investment. Capital investment yields over a number of years in future. It is by comparing rate of return on capital investment with the current rate of interest that decision regarding investment is taken. Further, the demand for firm’s output depends on the price of tits product, prices of competing products, incomes of the people and advertisement expenditure by a firm to promote its sales. If the demand forecast of a firm reveals that the demand for its product is not enough it can think of stepping up expenditure on advertisement to raise its market-share (that is, its share in the total market demand for the product). Further, to raise demand of its product or its market share, a firm can pursue other strategies such as properly adjusting its price policy or model of its product.

Demand forecasting for a product may be in respect of (1) aggregate demand, that is, total demand for output in the economy at a future time. (2) Total demand for the product of an industry and (3) the demand for the product of an individual firm. As regards aggregate demand, it is usually measured by the level of gross national product (GNP). However, an individual firm is more interested in forecasting demand for its own product or its market share rather than gross national product.

Need of demand forecasting

             Demand forecasts are needed not only by established firms but also by the new firms, who are planning to enter an industry. If they think the demand for the product is large enough, it will decide to produce the product and thus enter the industry, inadequate demand forecast for the product will prevent the entry of firms in the industry. Moreover, established firms may be interested in predicting demand for anew product which they will be launching. It will forecast demand for the new product by taking expenditure it wishes to make on it and overall future level of economic activity (i.e., level of income).

Importance of demand forecasting

Demand forecast plays an important role in planning for future level of production, for launching a new product, for expanding production capacity (i.e., making further capital investment) and for entering an industry. This helps a manager to acquire the needed plant and capital equipment, the quantity of required raw materials, the necessary skilled labour and other type of human resources. There can hardly be any capital investment or planning for future production if uncertainty prevails about the likely demand for the product. Therefore, forecast of demand greatly helps in business decisions by reducing uncertainty under which firms operate.

Types of demand forecasting

            Based on the time span, Demand forecasting can be for the immediate short term or the long term. Short term demand forecasting is limited to short periods, say, 3 months to one or two years. Such forecasts are made to plan production, purchases and arranging for finance, for the immediate future. If a scarcity of raw materials or spares is anticipated, immediate purchases of the same have to be made. They also help a firm to give shape it’s sales and distribution policies.

            Long term forecasting enables a firm to forecast the long demand for it’s product. In order to be successful, a firm should be well prepared to face the distant future. If an increase in demand is anticipated, the firm may have to expand it’s plant capacity, increase the purchase of machinery and fixed equipment. A multi product firm must take into consideration, the future demand conditions of the various products it produces. It is also important for the firm to take into consideration, the level of competition, the activity of competitors, the price of conditions in the future and other macroeconomic factors. Long-term forecasts, however, may not be as accurate as short term forecasts. Demand forecasting may also be undertaken at three different levels-firm level, industry level and economy level.

Firm level

            This refers to demand forecasting for a micro entity, i.e. the firm’s products. Any individual firm may be interested in knowing the demand for it’s product in the future. This is necessary for decision making and forward planning. TELCO, for instance would have to forecast in advance the demand for ‘INDICA’, taking into consideration the overall environment for the car industry in general, small cars particularly, the possible introduction of new brands into the small car segment, the government’s policies and a host of other factors.

Industry level

            Here the forecasting of demand is for the industry as a whole. This kind of forecasting may be done by certain firms belonging to the same industry or by industry associations like cement manufacturers association, automobile manufacturers association or Chambers of commerce and other research agencies.

Economy level

            Here the demand forecasting is done for the economy as a whole and is based on Macro level parameters like national income, national expenditure, change in political environment, change in consumption habits, entry of multinational and transnational companies, global changes and their impact on the Indian economy, prediction of favorable or unfavorable monsoons and a host of other factors.

Objectives of demand forecasting

            Demand forecasting has the following objectives:

1. To formulate suitable production policy so that there may not be any over-production or under-production.
2. To formulate proper price policies so that the level of price does not fluctuate too much in the periods of Depression or inflation.
3. To reduce costs of raw materials and control inventories (i.e., to stock enough raw material according to demand estimates)
4. To arrange for short-term financial requirements, such as working capital for day-to-day requirements.
5. To set sales targets based on demand estimates and provide incentives to sellers.
6. To arrange for promotional efforts, such as advertising and sales campaigns, etc.
7. To help the management to access the suitable labor requirements so as to ensure the best labor facility in the production process.

Factors involved in demand forecasting

            Before we attempt to apply the methods and techniques of forecasting, we should consider the relevance of the following factors which involved in demand or sales forecasting:

1.      Time period forecast

2.      Level of forecast

3.      Nature of forecast

1. Time period forecast

            It covers both short-term forecasts and long-term forecasts. Short-term forecasts cover any period upto one year, since policy changes pertaining to taxation, sales promotion, etc., can not be predicted for more than a year. But long-term forecasts cover a period upto 15 years; the future becomes so uncertain that the predict9ion becomes doubtful.

2. Level of Forecast

            It refers to a demand or sales forecast under-taken at different levels-macro level, industry and firm level.

            At the macro level, forecasting deals with the general economic conditions, and is measured by the index of industrial production, national income, employment or expenditure.

            At the industry level, for example, the product of automobiles are particularly interested in changes in the age composition of the population and the extent of changes in the consumer installment debt because these factors have a considerable effect on the sales of automobiles.

            At the firm level, the management is mostly interested in evaluating the impact of its own actions and the effects of outside forces on demand.

3. The nature of Forecast

            It is an equally important factor which influences the demand forecasting. The forecast may be either general or specific. A general forecast gives the global environment in which the business operates. Many firms adopt a mix of both because too much generalization obscures the real picture and too little provides insufficient basis for planning and execution.

General approach to demand forecasting

            There are four distinct steps in dealing with any demand forecasting problem. They are as follows:

1. Identity and clearly state the objectives of the forecasting problem.
2. Ascertain the determinants of demand for the product or product group, pertaining to consumer’s non-durable, consumer’s durable and capital goods.
3. Select appropriate methods of forecasting so as to obtain the best result.
4. Prepare the forecast and interrupt the findings.

The focus of the foregoing approach has been on the total demand for an product or product group. Once a product forecast has been made for the whole industry, the company will be interested in estimating the share of the market that it can get. However business forecasting calls for a flexible approach on the part of the analyst and the management.

            There are two approaches to the problem of demand forecasting for established products.

1. To obtain information about the intentions of buyers through collecting experts opinion or by conducting interviews with consumers.
2. To use past experience as guide and by extrapolating past statistical relationships to suggest the level of future demand.

Methods of demand forecasting

            There are several methods which can be used to forecast future demand for the products. The following are some of the important alternative techniques used for forecasting demand:

1.      Consumer Survey Method

2.      Expert Opinion

3.      Market Experiments

4.      Time Series Analysis

5.      Econometric Method

We shall explain below these alternative techniques of forecasting demand.

1. Consumer survey Method

            A direct method to obtain information future demand for gods is to conduct a survey, surveys are important technique for short-term forecasts. If data from existing sources do not meet their requirements or are not available, the firms conduct their own survey. This changes in the existing product. Surveys generally involve use of conducting consumer interviews or sending mailed questionnaire asking consumers their intentions or plans demand for goods.

            There are two types of surveys

(1)   Complete enumeration and

(2)   Sample survey

Complete enumeration

            Just like population census in this all consumers of a product are asked questions about quantity of a product they plan to buy in future if the price of the good is increased, say by 10 percent. With the information so gathered regarding of all consumers to buy a commodity, total demand for the product and changes in it resulting from changed n price can be estimated.

            The chief merit of this method of complete enumeration is that it is free from any bias or value judgement of the investigator. The investigator simply records the data or information. But it is very costly, tedious and cumbersome process. Therefore, it cannot be applied when a larger number of consumers are involved.

Sample Survey Method

            In this sample survey method, only a few consumers are selected at random or on a stratified basis. Through personal interviews or mailed questionnaire, questions are asked from them about their intended demand for a product and their response to changes in price of the product, their incomes, price of competing products. The data so collected is classified and tabulated for analysis of consumers’ demand.

2. Expert Opinion Method

            An alternative method of demand forecasting is to obtain views of specialists who are well-informed about the market possibilities of a product. These specialists or experts may be of the organization or firm itself. For example, the executives and sales managers of the firm may be asked to estimate future market possibilities of a product. There may be outside experts such as consultant firms, investment analysts, who are professionally trained for the purpose of forecasting demand. Although predictions of demand by experts are not always based on any hard data but they can provide useful information about demand for the product. There are various methods of confirming the opinion regarding future demand by experts. One such method id Delphi technique which we explain below:

Delphi Technique

            In Delphi technique opinion of a number of experts about future demand is first obtained. Then, each expert is told about the prediction of the other experts and asked in the light of the other’s views whether he would revise his prediction about future demand. The experts are again shown each other’s revised forecasts and asked to reconsider their forecasts further till a consensus is reached or until referring the opinion of others again to the experts result in little or no change in demand forecasts.

Survey of Sales Force

            When it is very costly or otherwise not possible to conduct complete enumeration or a sample survey of consumer’s intentions or seek expert opinion about future demand, a firm may enquire from its sales-representatives or salesman about their estimates of sales of its product in future. Thus, in this method information regarding likely sales is obtained from those who are closest to the market and have a intimate insight of the market. The responses of the various salesman or representatives are then aggregated to arrive at total demand forecast for the product.

            This method has many advantages. It is cheap and easy to do. It has further advantage of increasing the motivation of salesman to achieve the self-selected target for which they had made a forecast when they were asked to provide their prediction for future sales.

3. Market Experiments

            Business firms can also make market experiments to forecast demand for their products especially when they make changes in price, advertising expenditure, or to introduce a new product in the market. A big problem with the survey technique of demand forecasting explained above is that consumer responses in the survey may not correspond to actual consumer behavior. That is, consumers do not necessarily behave in the way they say when surveyed. This problem ac be partly overcome by the use of market experiments. The two types of market experiment are generally used: (1) Test Marketing and (2) Controlled Experiments.

Test Marketing

            In this technique the first step is to select a particular test area which accurately represents the whole market in which the new product is to be launched. Thus market area for testing may consist of several cities and town, or a particular representative region of the country or a sample of consumers’ taken form a mailing list.

Controlled Experiments

            An alternative type of market experiments is controlled experiments which are conducted to test the demand for a new product by a firm or to test the demands for various brands of a product. In a controlled experiment, a sample of some consumers of a product which are representative of the target market is selected. They are asked to visit a shopping store of a firm where various brands of a product are placed for sale. These visiting consumers are asked which and how much of each brand they would by at different prices. Their preferences are recorded. They are then provided advertising materials for various brands. Now, the selected samples of consumers are given certain fixed money and asked to make purchases of the products or various brands of a product. The quantity of the product or particular brands of a product purchased by them is recorded. A questionnaire may also be prepared to ask the reasons for the particular choice they have made. The price of the product or its model may be changed and the experiment is repeated.

4. Time series analysis

            Time series analysis is an important technique of forecasting demand which is widely used by business world. As shall be explained below, time series analysis contains more than one technique of forecasting of time series analysis uses only past or historical values of a variable to predict future values. It may be noted that the time-series analysis does not attempt to explain the casual relationship between variables that determine future value of a given variable.

1. Trends

            These are long-term increase or decrease in time series of a variable (i.e., demand or sales of product in the present analysis of demand forecasting). For example, increasing population over time or changing consumers tastes may result in long-term increase or decrease of a demand for a product over time.

2. Seasonal variations

            These are the changes in demand series over time due to changes in seasons during a year. Seasonal effects are generally consistent from year to year.

3. Cyclical variations

            These are substantial expansion or contraction in an economic variable (demand or sales in the present analysis) that are usually more than a year’s duration. In cyclical variations in an economic series sustained periods of high values of variable are followed by its low values. In most industries cyclical changes in demand are not consistent or predictable over time. It may be noted that cyclical variations in a variable caused by different types of factors.

5. Econometric method

            Another important forecasting technique used by the managerial economist is the econometric model. Econometric is the use of statistical methods and economic theory to estimate the casual relationship between economic variables. On the basis of economic theory a mathematical model describing relationship between economic variables is established. Then through the use of statistical methods estimates of parameters are made. With the help of these parameters forecasting of demand is made. Econometric technique has a number of important advantaged over time-series analysis, survey technique, except opinion or sales force polling and barometric methods. The most important advantage of econometric model is that it not only enables us to forecast an econometric phenomenon but also explains it. That is, it establishes casual relationships between economic variables.

Forecasting demand for a new product

            Joel Dean has suggested six approaches for forecasting demand for a new product.

1. Evolutionary approach

            Under this method the demand for a new product is estimated on the basis of an existing old product. For example, the demand for colour TV is based on the demand for Black and White TV sets. This approach is useful only when product is close to the old product or an improvement over the existing product.

2. Substitute approach

            Under this method, the demand for a new product is analyzed as a substitute of the old product. The demand for cell phones can be studied as a substitutes for telephones.

3. Growth curve approach

            Under this method, it is assumed that the growth trend of the new product would be similar to that of an existing product. For example by analyzing the past growth trend of cycles in general, the growth trend of a new cycle brand can be predicted.

4. Opinion approach

            Here the consumers are directly interviewed and information pertaining to their opinions and purchase intentions are obtained.

5. Sales experience approach

            Here, the product is actually introduced in the market (say, a departmental store, super market) and the reaction of the consumers, is observed. Under this method, interpretation can be made only after taking into consideration the peculiar characteristics of the sample market.

6. Indirect approach

            Under this method, the opinion of specialized dealers of similar products are obtained.

Features of Good Forecasting Method

1. Accuracy

            The method of forecasting should give accurate results. If the results of the research form the basis of various managerial decisions, it should be reliable and accurate.

2. Simplicity

            The method should not involve complicated Mathematical and econometric models and should be easily understood. The chances of errors are high, if the method gets complicated.

3. Economy

            The method employed should produce a accurate results with minimum cost.

4. Time

            Time factor is very important, because, if the forecast takes a very long time, it will not only be expensive, but the results of the forecast may lose it’s utility.

5. Flexible

            The method should be as flexible as possible, so as to accommodate any characteristic environment that may take place with future.

6. Easily available

 The method should be such that the date required are easily available.


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