Demand forecasting

Why Demand Forecasting?

Demand results in sales Which is the primary source of Revenue Predicting future demand for a product To avoid under or over production Minimize the Uncertainties Rough estimate of the demand prospects

Demand forecasting helps in planning to acquire inputs ( men & material), organizing production, advertisement and organizing sales channels.

Purpose of Forecasting Demand

Short run Forecast : Seasonal patterns are important Forecasting helps in preparing suitable sales policy and proper scheduling of output. Pricing policy and modification in advertising and sales techniques Long-run Forecast : Capital planning Planning of production, material, man-hours, machine time Changes in variables are included

Steps Involved in Forecasting

Identification of Objective

Estimation of one / more than one aspect

Nature of Goods

Goods have different demand pattern

Selection of method Of Forecasting

Interpretation of Results

Steps Involved in Forecasting

Time Horizon

Demand Forecast Determined

Methods of Demand Forecasting

Techniques

Survey Methods

Statistical Methods

Consumer Survey Direct Interview

Opinion Poll Methods

Trend Projection

Econometric Methods

Survey Methods
Where the purpose is to make short- run forecast of demand. Consumer surveys are conducted to collect information about their intentions and future plans.

1) Survey of potential consumers on their intentions and plan. 2) Opinion polling of experts

1) Consumer Survey Method

Direct Interview with the potential consumers. Ask what quantity of the product would they buy at different prices over a given period of time.

Consumer Survey Method

Complete Enumeration Method

Sample Survey

End-Use Method

a) Complete Enumeration Method:

All potential users of the product are contacted and asked about their future plans of purchasing the product The quantities indicated by the consumers are added together to obtain demand of the product Dp = q1 + q2 + q3+..+ qn n = qi i=1

Limitation:
1) 2) 3) 4) 5) Only successful if consumers are concentrated in a certain region or locality. Consumers actual demand in future may not be known Consumers may give hypothetical answers Consumers response could be biased to their expectations Consumers plan may change with the change in factors not included in questionnaire

b) Sample Survey Method:

Only few potential consumers /users are selected. Its through face to face/ telephonic interview or mailed / web questionnaire On the information, the probable demand may be estimated. Less costly, less time- consuming Used to estimate short-term demand (yearly)

Dp = HR HS

( H. AD )

Dp = probable demand forecast H = Census number of households Hs = Sample Household Hr = No of HH reporting demand for the product Ad = Avg expected consumption ( Total quantity reported to be consumed / no of hh)

Business firms, Government departments and Households plan their expenditure one year in advance. Therefore they can supply a fairly reliable estimate of their future expectations.

Limitations: Similar to complete enumerations Quantification of variables (e,g Feelings, opinions, expectations) is not possible

c) End- Use Method:

Requires building up schedule for probable aggregate future demands for inputs by consuming industries / sectors Technological, structural & other changes which might influence the demand are taken into account in the process of estimation More relevant for B2B markets

c) End- Use Method:

Stage 1 Stage 2 : List all possible uses of the product

: Fix suitable technical norms for each end use Per unit of production of complete product / per unit of investment / per capita use Questionnaires used to collect relevant information

Stage 3 : Application of Norms Necessary to know targeted levels of output of individual industries for the target year And likely development in other economic activities which use the product & likely output targets Stage 4 : Aggregation of demand of each end use

Limitations

Enumeration of all possible uses due to lack of published data Despatch records of the manufactures, if available need not enumerate all the final users. Impossible to organise and collect data of wide network of wholesale and retail agencies Possibility of missing out end-uses or new applications Therefore estimations should provide some margin of error Establishing norms is difficult Inaccuracy in estimating sales of target industries

Advantages
Probing into current use-pattern of consumption of product it provides opportunity to determine the demand by types, categories & sizes etc It facilitates in diagnosis & pin-pointing as to where & why did the actual consumption deviate from estimated demand

2) Opinion Poll Method

Aims at collecting opinions of those who possess knowledge of the market Sales representatives, sales executives, marketing experts and consultants

Opinion Poll

Expert -Opinion

Delphi method

Market studies/ experiment

a)

Expert Opinion Method: Firms having good network of sales representatives can ask them to assess demand As they are in touch with consumers and consumption pattern Can provide a approximate figure of likely demand

Limitations: Estimates are reliable only to the extent of their skill to analyse the market. The assessor may have subjective judgement which may lead to over / under estimation Inadequate information may be available to the assessor as they may have narrow view of the market.

b)

Delphi Method: To consolidate the expert opinions and arrive at estimate of future demand. Experts are provided information on the estimates of other experts, and they revise their own estimates

The consensus of experts about the forecast constitutes the final forecast

This technique can be used for cross checking information on forecasts.

c)

Market studies and experiments To carry out studies on consumer behaviour under actual, controlled market conditions. Market studies: Firms select areas of market having similar features ( populations, income levels, cultural/ social backgrounds, choices.) Carry out experiments by changing variables of demand functions Consequent changes in demand are recorded Assessment of demand of the product is made. Experiments: Consumers are given money to buy goods with varying prices, packages, displays It reveals consumers responsiveness to the changes

Limitations:
Expensive unaffordable for small firms Experiments are carried out on a small scale leads to generalization Studies are based on short term and controlled conditions may not exist in uncontrolled market. Changes in socio-economic , climatic conditions may alter the results.

Statistical Methods
Advantages Subjectivity is minimum Method of estimation is scientific Estimates are relatively more reliable Involves smaller cost Methods 1) Trend Projection Method 2) Econometric Method

a)

Trend Projection

It is a study of movement of variables through time. Requires long and reliable time-series data Its based on the assumption that factors responsible for the past trends will continue to be the same in future. a) Graphical Method: Annual sales data is plotted on a graph Line is drawn through the plotted points Free line is drawn that the total distance between the line and points is minimum. Second line drawn taking the mid values of variations. The trend line is then extended to forecast the demand for next year. The projections may not be realisable as the extension of trend line involves subjectivity and personal bias.

1)

Graphical Method

Sales

Year

2) Fitting Trend equation:

b) Fitting Trend equation: Least square method:

Trend line is fitted to the time-series data Linear best fit curve Minimises the deviation of the actual line
S = a + bT S = Annual sales T = time (years) a & b are constant S = na + b T ST = a T + b T
2

b) Econometric Method
It combines statistical tools with economic theories to estimate economic variables. Forecast are more reliable This model try to identify all those economic and demographic variables that influence the future value of the variable under forecast. Two types of method: a) Regression method b) Simultaneous method

b) Econometric Method
a) Regression method Establishes casual relationship between Dependent variable (demand) Independent variables (parameters that impact demand) Most popular method

As it combines Economic theory To specific determinants of demand & their relationship with demand Statistical techniques To estimate the values of parameter in the equation. Or estimate the impact in the demand for a unit change in the determinant

b) Econometric Method
a) Regression method

Simple / Bivariate regression

If demand of a commodity depends on a single independent variable E.g. demand for salt / sugar depends largely on population The relationship can be established using least square method As used in time series Only difference is time is replaced by the independent variable on which the demand depends the most

b) Econometric Method
a) Regression method Multi-variate regression If demand of a commodity depends on a more than one independent variables E.g. demand for sweets, fruits, & vegetables depends on price of the product, price of its substitutes, household income, population etc. Procedure Specify variables that have an impact on demand. This will be different for different categories Next specify the form of equation linear, logarithmic, power etc Collect the necessary data Estimate the value of co-efficient of the independent variables through statistical techniques. Essentially done with the help of computer

b) Econometric Method
a) Regression method
It uses one single equation It assumes one-way causation i.e. only independent variable causes variation in dependent variable and not vice versa However, realistically demand for a product also has an impact on price of the product
This issue can be addressed through simultaneous equation model

b) Econometric Method
b) Simultaneous method
Is a complete & systematic approach to forecasting It involves solving several simultaneous equations for estimating demand. It takes two- way causation i.e: simultaneous interaction between dependent and independent variable. As well as inter-dependence of independent variables

For instance
Demand for white goods depends on product price, price of substitute, household income, consumer preference, availability of credit & interest rate Interest rate depends on Availability of credit Which in turn may depend on many other economic parameters & government policies at that point. And so on

Thus estimation of demand will require solving all such functions simultaneously

Salient features of good forecasting method

Simplicity Accuracy Economy Availability Applicability Though mere possession of right tools is does not necessarily mean accurate forecast. Equally important is analysts judgement.