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CHAPTER 4 MARKET AND DEMAND ANALYSIS

CHAPTER 4 MARKET AND DEMAND ANALYSIS

OUTLINE

Situational analysis and specification of objectives

Collection of secondary information

Conduct of market survey

Characterisation of the market

Demand forecasting

Uncertainties in demand forecasting

Market planning

Key Steps in Market and Demand Analysis and their Inter-relationships

Collection of Secondary Information Demand Forecasting Situational Analysis and Specification of Objectives
Collection of
Secondary
Information
Demand
Forecasting
Situational
Analysis and
Specification
of Objectives
Characterisation
of the Market
Conduct of
Market Survey
Market
Planning
Analysis and Specification of Objectives Characterisation of the Market Conduct of Market Survey Market Planning

Situational Analysis

In order to get a “feel” of the relationship between the product and its market, the project analyst may informally talk to customers, competitors, middlemen, and others in the industry. Wherever possible, he may look at the experience of the company to learn about the preferences and purchasing power of customers, actions and strategies of competitors, and practices of the middlemen.

the preferences and purchasing power of customers, actions and strategies of competitors, and practices of the

Collection of Secondary Information

SecondarySecondary informationinformation isis informationinformation thatthat hashas beenbeen gatheredgathered inin somesome otherother contextcontext andand isis readilyreadily available.available.

SecondarySecondary informationinformation providesprovides thethe basebase andand thethe startingstarting pointpoint forfor thethe marketmarket andand demanddemand analysis.analysis. ItIt indicatesindicates whatwhat isis knownknown andand oftenoften providesprovides leadsleads andand cuescues forfor gatheringgathering primaryprimary informationinformation requiredrequired forfor furtherfurther analysis.analysis.

Evaluation of Secondary Information

While secondary information is available economically and readily (provided the market analyst is able to locate it), its reliability, accuracy, and relevance for the purpose under consideration must be carefully examined. The market analyst should seek to know:

Who gathered the information? What was the objective?

When was the information gathered? When was it published?

How representative was the period for which the information was gathered?

Have the terms in the study been carefully and unambiguously defined?

What was the target population?

How was the sample chosen?

How representative was the sample?

How satisfactory was the process of information gathering?

What was the degree of sampling bias and non-response bias in the information

gathered?

What was the degree of misrepresentation by respondents?

Market Survey

SecondarySecondary information,information, thoughthough useful,useful, oftenoften doesdoes notnot provideprovide aa comprehensivecomprehensive basisbasis forfor marketmarket andand demanddemand analysis.analysis. ItIt needsneeds toto bebe supplementedsupplemented withwith primaryprimary informationinformation gatheredgathered throughthrough aa marketmarket survey.survey.

TheThe marketmarket surveysurvey maymay bebe aa censuscensus surveysurvey oror aa samplesample survey;survey; typicallytypically itit isis thethe latter.latter.

bebe aa censuscensus surveysurvey oror aa samplesample survey;survey; typicallytypically itit isis thethe latter.latter.

Information Sought in a Market Survey

The information sought in a market survey may relate to one or more of the following:

Total demand and rate of growth of demand

Demand in different segments of the market

Income and price elasticities of demand

Motives for buying

Purchasing plans and intentions

Satisfaction with existing products

Unsatisfied needs

Attitudes toward various products

Distributive trade practices and preferences

Socio-economic characteristics of buyers

Steps in a Sample Survey

Typically, a sample survey involves the following steps:

1. Define the target population.

2. Select the sampling scheme and sample size.

3. Develop the questionnaire.

4. Recruit and train the field investigators.

5. Obtain information as per the questionnaire from the sample of respondents.

6. Scrutinise the information gathered.

7. Analyse and interpret the information.

Characterisation of the Market

Based on the information gathered from secondary sources and through the market survey, the market for the product/service may be described in terms of the following:

• Effective demand in the past and present

• Breakdown of demand

• Price

• Methods of distribution and sales promotion

• Consumers

• Supply and competition

• Government policy

Methods of Demand Forecasting

I Qualitative Methods : These methods rely essentially on the judgment of experts to

translate qualitative information into quantitative estimates. The important qualitative methods are :

Jury of executive method

Delphi method

II Time Series Projection Methods : These methods generate forecasts on the basis of an analysis of the historical time series . The important time series projection methods are :

Trend projection –method

Exponential smoothing method

Moving average method

III Causal Methods : More analytical than the preceding methods, causal methods

seek to develop forecasts on the basis of cause-effect relationships specified in an explicit, quantitative manner. The important causal methods are :

Chain ratio method

Consumption level method

End use method

Leading indicator method

Econometric method

Chain ratio method  Consumption level method  End use method  Leading indicator method 

Jury of Executive Opinion Method

This method involves soliciting the opinion of a group of managers on expected future sales and combining them into a sales estimate

Pros

• It is an expeditious method

• It permits a wide range of factors to be considered

• It appeals to managers

Cons

The biases cannot be unearthed easily

Its reliability is questionable

Delphi Method

This method is used for eliciting the opinions of a group of experts with the help of a mail survey. The steps involved in this method are :

1.1. AA groupgroup ofof expertsexperts isis sentsent aa questionnairequestionnaire byby mailmail andand askedasked toto expressexpress theirtheir views.views.

2.2. TheThe responsesresponses receivedreceived fromfrom thethe expertsexperts areare summarisedsummarised withoutwithout disclosingdisclosing thethe identityidentity ofof thethe experts,experts, andand sentsent backback toto thethe experts,experts, alongalong withwith aa questionnairequestionnaire meantmeant toto probeprobe furtherfurther thethe reasonsreasons forfor extremeextreme viewsviews expressedexpressed inin thethe firstfirst round.round.

3.3. TheThe processprocess maymay bebe continuedcontinued forfor oneone oror moremore roundsrounds tilltill aa reasonablereasonable agreementagreement emergesemerges inin thethe viewview ofof thethe experts.experts.

Pros

• It is intelligible to users

• It seems to be more accurate and less expensive than the

traditional face-to-face group meetings

Cons

There are some question marks: What is the value of the expert opinion? What is the contribution of additional rounds and feedback to accuracy?

Trend Projection Method

The trend projection method involves (a) determining the trend of consumption by analysing past consumption statistics and (b) projecting future consumption by extrapolating the trend.

Linear relationship

Exponential relationship

Polynomial relationship

Cobb Douglas relationship

: Yt

=

: Yt

=

: Yt

=

: Yt

=

a + bT

ae bt

a 0

at b

+ a 1 t + a 2 t 2 …….a n t n

Exponential Smoothing Method

In exponential smoothing, forecasts are modified in the light of observed errors. If the forecast value for year t, F t , is less than the actual value for year t, S t , the forecast for the year t+1, F t+1 , is set higher than F t . If F t > S t , F t+1 is set lower than F t . In general

F t+1 =

F t + e t

(4.7)

where

Ft + 1

= forecast for year t + 1

α

= smoothing parameter (which lies between 0 and 1)

et

= error in the forecast for year t = St - Ft

Moving Average Method

As per the moving average method of sales forecasting, the forecast for the next period is equal to the average of the sales for several preceding periods.

In symbols,

S t + S t-1 + +

S t-n+1

F t+1

=

n

where F t+1 =

=

S

n

t

=

forecast for the next period

sales for the current period

period over which averaging is done

(4.8)

Chain Ratio Method

The potential sales of a product may be estimated by applying a series of factors

measure of aggregate demand. For example, the General Foods of the U. S estimated the potential sales for a new product, a freeze-fried instant coffee (Maxim), in the following manner :

to

a

TotalTotal amountamount ofof coffeecoffee salessales

::

174.5174.5 millionmillion unitsunits

ProportionProportion ofof coffeecoffee usedused atat homehome

::

0.8350.835

CoffeeCoffee usedused atat homehome

::

145.7145.7 millionmillion unitsunits

ProportionProportion ofof non-decaffeinatednon-decaffeinated coffeecoffee usedused atat homehome

::

0.9370.937

Non-decaffeinatedNon-decaffeinated coffeecoffee usedused atat homehome

::

136.5136.5 millionmillion unitsunits

ProportionProportion ofof instantinstant coffeecoffee

::

0.4000.400

InstantInstant non-decaffeinatednon-decaffeinated coffeecoffee usedused atat homehome

::

54.654.6 millionmillion unitsunits

EstimatedEstimated long-runlong-run marketmarket shareshare forfor MaximMaxim

::

0.080.08

PotentialPotential salessales ofof MaximMaxim

::

4.374.37 millionmillion unitsunits

Consumption Level Method

The method estimates consumption level on the basis of elasticity coefficients, the important ones being the income elasticity of demand and the price elasticity of demand.

of elasticity coefficients, the important ones being the income elasticity of demand and the price elasticity

Income Elasticity of Demand

The income elasticity of demand reflects the responsiveness of demand to variations in income. It is measured as follows :

E

I =

Q 2 -Q 1

I 2 I 1

I 1 + I 2

x

Q 2 +Q 1

(4.9)

where E I = income elasticity of demand Q 1 = quantity demanded in the base year Q 2 = quantity demanded in the following year I 1 = income level in the base year I 2 = income level in the following year.

The following information is available on quantity demanded and income

level: Q 1 = 50 , Q 2 = 55 , I 1 = 1,000 and I 2 = 1,020 . What is the income elasticity of

Example

demand? The income elasticity of demand is :

E

I =

55 – 50

1 020

1 000

x

1,000 + 1,020

55 + 50

=

4.81

Price Elasticity of Demand

The price elasticity of demand measures the responsiveness of demand to variations in price. It is defined as :

where

Q 2

Q 1

P 1 + P 2

E

p =

x

2 P 1

E p = price elasticity of demand

Q 1 = quantity demanded in the base year Q 2 = quantity demanded in the following year

P

Q 2 + Q 1

P

1 = price per unit in the base year

P

2 = price per unit in the following year

(4.10)

Example

P 1 = Rs.600, Q 1 = 10,000,

demand? The price elasticity of demand is :

The following information is available about a certain product :

P 2 = Rs. 800, Q 2 = 9,000. What is the price elasticity of

9,000 – 10,000

600 + 800

E p =

600 – 800

x

=

9 000 +10 000

- 0.37

End Use Method

Suitable for estimating the demand for intermediate products, the end use method, also referred to as the consumption coefficient method, involves the following steps:

1. Identify the possible uses of the product.

2. Define the consumption coefficient of the product for various uses.

3. Project the output levels for the consuming industries.

4. Derive the demand for the product.

Project Demand for Indchem

This method may be illustrated with an example. A certain industrial chemical, Indchem is used by four industries Alpha, Beta, Gamma, and Kappa.

The consumption coefficients for these industries, the projected output levels for these industries for the year X, and the projected demand for Indchem as shown in the following slide.

ConsumptioConsumptio nn CoefficientCoefficient **

ProjectedProjected

OutputOutput inin yearyear

XX

ProjectedProjected DemandDemand forfor

IndchemIndchem inin yearyear

XX

AlphaAlpha

2.02.0

10,00010,000

20,00020,000

BetaBeta

1.21.2

15,00015,000

18,00018,000

KappaKappa

0.80.8

20,00020,000

16,00016,000

GammaGamma

0.50.5

30,00030,000

15,00015,000

 

TotalTotal

69,00069,000

** ThisThis isis expressedexpressed inin tonnestonnes ofof IndchemIndchem requiredrequired perper unitunit ofof outputoutput ofof thethe consumingconsuming industryindustry

Bass Diffusion Model - 1

Developed by Frank Bass, the Bass diffusion model seeks to estimate the pattern of sales growth for new products, in terms of two factors:

p : The coefficient of innovation. It reflects the likelihood that a potential customer

would adopt the product because of its innovative features.

q : The coefficient of imitation. It reflects the tendency of a potential customer to

buy the product because many others have bought it. It can be regarded as a

network effect.

According to a linear approximation of the model:

n t = pN + ( q – p ) N t-1 + ( q / N ) x ( N t-1 ) 2

where n t , is the sales in period t, p is the coefficient of innovation, N is the potential size of the market, q is the coefficient of imitation, and N t is the accumulative sales made until period.

Bass Diffusion Model - 2

A new product has a potential market size of 1,000,000. There is an older product that

is similar to the new product.

this older product. The sales trend of the new product is expected to be similar to the older product.

Applying the Bass diffusion model, we get the following estimates of sales in year 1 and year 2.

p = 0.030 and q = 0.080 describe the industry sales of

n 1 = 0.03 x 1,000,000 + (0.08 – 0.03) x +

0.080

1,000,000

x

0 2 = 30,000

n 2 = 0.03 x 1,000,000 + (0.08 – 0.03) x 30,000 + (0.08 / 1,000,000) x (30,000) 2

Leading Indicator Method

Leading indicators are variables which change ahead of other variables, the lagging variables. Hence, observed changes in leading indicators may be used to predict the changes in lagging variables. For example, the change in the level of urbanisation ( a leading indicator) may be used to predict the change in the demand for air conditioners (a lagging variable)

Two basic steps are involved in using the leading indicator method: (i) First, identify the appropriate leading indicator(s).(ii) Second, establish the relationship between the leading indicator(s) and the variable to be forecast.

The principal merit of this method is that it does not require a forecast of an explanatory variable. Its limitations are that it may be difficult to find appropriate leading indicator(s) and the lead-lag relationship may not be stable over time.

Econometric Method

AnAn econometriceconometric modelmodel isis aa mathematicalmathematical representationrepresentation ofof economiceconomic relationship(s)relationship(s) derivedderived fromfrom economiceconomic theory.theory. TheThe primaryprimary objectiveobjective ofof econometriceconometric analysisanalysis isis toto forecastforecast thethe futurefuture behaviourbehaviour ofof thethe economiceconomic variablesvariables incorporatedincorporated inin thethe model.model.

TwoTwo typestypes ofof econometriceconometric modelsmodels areare employed:employed: thethe singlesingle equationequation modelmodel andand thethe simultaneoussimultaneous equationequation modelmodel

thethe singlesingle equationequation modelmodel andand thethe simultaneoussimultaneous equationequation modelmodel

Single Equation Model

The single equation model assumes that one variable, the dependent variable (also referred to as the explained variable), is influenced by one or more independent variables (also referred to as the explanatory variables). In other words, one-way causality is postulated. An example of the single equation model is given below:

D t = a 0 + a 1 P t + a 2 N t

(4.11)

where D t = demand for a certain product in year t P t = price for the product in year t N t = income in year t

Simultaneous Equation Model

The simultaneous equation model portrays economic relationships in terms of two or more equations. Consider a highly simplified three- equation econometric model of Indian economy.

where

GNP t = G t + I t + C t

I t

= a 0 + a 1 GNP t

C t = b 0 + b 1 GNP 1

GNP t = gross national product for year t G t = governmental purchases for year t

I t

= gross investment for year t

C t = consumption for year t

(4.12)

(4.13)

(4.14)

Improving Forecasts

You can improve forecasts by following some simple guidelines:

• Check assumptions

• Stress fundamentals

• Beware of history

• Watch out for euphoria

• Don’t be dazzled by technology

• Stay flexible

Uncertainties in Demand Forecasting

Demand forecasts are subject to error and uncertainty which arise from three principal sources:

• Data about past and present market

• Methods of forecasting

• Environmental change

from three principal sources: • Data about past and present market • Methods of forecasting •

Coping with Uncertainties

Given the uncertainties in demand forecasting, adequate efforts, along the following lines, may be made to cope with uncertainties.

ConductConduct analysisanalysis withwith datadata basedbased onon uniformuniform andand standardstandard definitions.definitions.

InIn identifyingidentifying trends,trends, coefficients,coefficients, andand relationships,relationships, ignoreignore thethe abnormalabnormal oror out-of-out-of- the-the- ordinaryordinary observations.observations.

CriticallyCritically evaluateevaluate thethe assumptionsassumptions ofof thethe forecastingforecasting methodsmethods andand choosechoose aa methodmethod whichwhich isis appropriateappropriate toto thethe situation.situation.

AdjustAdjust thethe projectionsprojections derivedderived fromfrom quantitativequantitative analysisanalysis inin thethe lightlight ofof unquantifiable,unquantifiable, butbut significant,significant, influences.influences.

MonitorMonitor thethe environmentenvironment imaginativelyimaginatively toto identifyidentify importantimportant changes.changes.

ConsiderConsider likelylikely alternativealternative scenariosscenarios andand theirtheir impactimpact onon marketmarket andand competition.competition.

ConductConduct sensitivitysensitivity analysisanalysis toto assessassess thethe impactimpact onon thethe sizesize ofof demanddemand forfor unfavourableunfavourable andand favourablefavourable variationsvariations ofof thethe determiningdetermining factorsfactors fromfrom theirtheir mostmost likelylikely levels.levels.

Market Planning

A marketing plan usually has the following components:

• Current marketing situation

• Opportunity and issue analysis

• Objectives

• Marketing strategy

• Action programme

Current marketing situation • Opportunity and issue analysis • Objectives • Marketing strategy • Action programme

SUMMARY

GivenGiven thethe importanceimportance ofof marketmarket andand demanddemand analysis,analysis, itit shouldshould bebe carriedcarried outout inin anan orderlyorderly andand systematicsystematic manner.manner. TheThe keykey stepssteps inin suchsuch analysisanalysis areare (i)(i) situationalsituational analysisanalysis andand specificationspecification ofof objectives,objectives, (ii)(ii) collectioncollection ofof secondarysecondary information,information, (iii)(iii) conductconduct ofof marketmarket survey,survey, (iv)(iv) characterisationcharacterisation ofof thethe market,market, (v)(v) demanddemand forecastingforecasting andand (vi)(vi) marketmarket planning.planning.

TheThe projectproject analystanalyst maymay dodo anan informalinformal situationalsituational analysisanalysis whichwhich inin turnturn maymay provideprovide thethe basisbasis forfor aa formalformal study.study.

ForFor purposespurposes ofof marketmarket study,study, informationinformation maymay bebe obtainedobtained fromfrom secondarysecondary andand /or/or primaryprimary sources.sources.

SecondarySecondary informationinformation isis informationinformation thatthat hashas beenbeen gatheredgathered inin somesome otherother contextcontext andand isis alreadyalready available.available. WhileWhile secondarysecondary informationinformation isis availableavailable economically,economically, itsits reliability,reliability, accuracy,accuracy, andand relevancerelevance forfor thethe purposepurpose underunder considerationconsideration mustmust bebe carefullycarefully examined.examined.

SecondarySecondary information,information, thoughthough useful,useful, oftenoften doesdoes notnot provideprovide aa comprehensivecomprehensive basisbasis forfor marketmarket andand demanddemand analysis.analysis. ItIt needsneeds toto bebe supplementedsupplemented withwith primaryprimary informationinformation gatheredgathered throughthrough aa marketmarket survey,survey, specificspecific toto thethe projectproject beingbeing appraised,appraised, thatthat isis likelylikely toto bebe aa samplesample survey.survey.

Typically,Typically, aa samplesample surveysurvey consistsconsists ofof thethe followingfollowing steps:steps: (i)(i) DefineDefine thethe targettarget populationpopulation (ii)(ii) SelectSelect thethe samplingsampling schemesschemes andand samplesample size.size. (iii)(iii) DevelopDevelop thethe questionnaire.questionnaire. (iv)(iv) ScrutiniseScrutinise thethe informationinformation gathered.gathered. (vii)(vii) AnalyseAnalyse andand interpretinterpret thethe information.information.

BasedBased onon thethe informationinformation gatheredgathered fromfrom secondarysecondary sourcessources andand throughthrough marketmarket survey,survey, thethe marketmarket forfor thethe product/serviceproduct/service maymay bebe describeddescribed inin termsterms ofof thethe following:following: effectiveeffective demanddemand inin thethe pastpast andand present;present; breakdownbreakdown ofof demand;demand; price;price; methodsmethods ofof distributiondistribution andand salessales promotion;promotion; consumers;consumers; supplysupply andand competition;competition; andand governmentgovernment policy.policy.

AfterAfter gatheringgathering informationinformation aboutabout variousvarious aspectsaspects ofof thethe marketmarket andand demanddemand fromfrom primaryprimary andand secondarysecondary sources,sources, anan attemptattempt maymay bebe mademade toto estimateestimate futurefuture demand.demand.

AA widewide rangerange ofof forecastingforecasting methodsmethods isis availableavailable toto thethe marketmarket analyst.analyst. TheseThese maymay bebe divideddivided intointo threethree broadbroad categories,categories, viz.,viz., qualitativequalitative methods,methods, timetime seriesseries projectionprojection methods,methods, andand causalcausal methods.methods.

QualitativeQualitative methodsmethods relyrely essentiallyessentially onon thethe judgmentjudgment ofof expertsexperts toto translatetranslate qualitativequalitative informationinformation intointo quantitativequantitative estimates.estimates. TheThe importantimportant qualitativequalitative methodsmethods areare :: JuryJury ofof executiveexecutive methodmethod andand DelphiDelphi method.method.

CausalCausal methodsmethods seekseek toto developdevelop forecastsforecasts onon thethe basisbasis ofof cause-effectcause-effect relationshipsrelationships specifiedspecified inin anan explicit,explicit, quantitativequantitative manner.manner. TheThe importantimportant causalcausal methodsmethods are:are:

chainchain ratioratio method,method, consumptionconsumption levellevel method,method, endend useuse method,method, leadingleading indicatorindicator method,method, andand econometriceconometric method.method.

ToTo enableenable thethe productproduct toto reachreach aa desireddesired levellevel ofof marketmarket penetration,penetration, aa suitablesuitable marketingmarketing plan,plan, coveringcovering pricing,pricing, distribution,distribution, promotion,promotion, andand service,service, needsneeds toto bebe developed.developed.

distribution,distribution, promotion,promotion, andand service,service, needsneeds toto bebe developed.developed.