Demand Forecasting

Meaning of Demand Forecasting

“An estimate of sales in dollars or physical units for

a specified future period under a proposed
marketing plan.”
American Marketing Association
Demand forecasting is the scientific and analytical
estimation of demand for a product (service) for a
particular period of time.
It is the process of determining how much of what
products is needed when and where.
An operations research technique of planning
and decision making.
Categorization of Demand Forecasting

By Level of Forecasting
Firm (Micro) level: forecasting of demand for its
product by an individual firm.
decisions related to production and marketing.
Industry level: for a product in an industry as a
whole. insight in growth pattern of the industry
in identifying the life cycle stage of the product
relative contribution of the industry in national
income.
Economy (Macro) level: forecasting of aggregate
demand (or output) in the economy as a whole.
helps in various policy formulations at
government level.
Categorization of Demand Forecasting
By nature of goods
Capital Goods: Derived demand
demand for capital goods depends upon demand of consumer
goods which they can produce.
Consumer Goods: Direct demand
durable consumer goods: new demand or replacement demand
Non durable consumer goods: FMCG
By Time Period
Short Term (0 to 3 months): for inventory management
and scheduling.
Medium Term (3 months to 2 years): for production
planning, purchasing, and distribution.
Long Term (2 years and more): may extend up to 10 to 20 years.
for capacity planning, facility location, and strategic planning, long term
capital requirement, and investment decisions.
Choice of a forecasting technique
depends on:
Imminent objectives of forecast, whether it is for a new
product, or to gauge impact of a new advertisement, etc.
Cost involved, cost of forecasting should not be more than its
benefits, here opportunity cost of resources will also be
important.
Time perspective, whether the forecast is meant for the
short run or the long run
Complexity of the technique, vis-à-vis availability of expertise;
this would determine whether the firm would look for experts “in
house” or outsource it
Nature and quality of available data, i.e. does the time series
show a clear trend or is it highly unstable.
Techniques of Demand Forecasting
Subjective (Qualitative) methods: rely on human judgment and
opinion.
Buyers’ Opinion
Sales Force Composite
Market Simulation
Test Marketing
Experts’ Opinion
Group Discussion
Delphi Method
Quantitative methods: use mathematical or simulation models
based on historical demand or relationships between variables.
Trend Projection
Smoothing Techniques
Barometric techniques
Econometric techniques
 Subjective Methods of Demand Forecasting

Consumers’ Opinion Survey

Buyers are asked about future buying intentions of products, brand
preferences and quantities of purchase, response to an increase in the
price, or an implied comparison with competitor’s products.
Census Method: Involves contacting each and every buyer
Sample Method: Involves only representative sample of buyers
Merits
Simple to administer and comprehend.
Suitable when no past data available.
Suitable for short term decisions regarding product and promotion.
Demerits
Expensive both in terms of resources and
time. Buyers may give incorrect responses.
Investigators’ bias regarding choice of sample and questions cannot
be fully eliminated.
Subjective Methods of Demand Forecasting
Contd…

Sales Force Composite

Salespersons are in direct contact with the customers. Salespersons
are asked about estimated sales targets in their respective sales
territories in a given period of time.
Merits
Cost effective as no additional cost is incurred on collection of data.
Estimated figures are more reliable, as they are based on the
notions of salespersons in direct contact with their customers.
Demerits
Results may be conditioned by the bias of optimism (or pessimism)
of salespersons.
Salespersons may be unaware of the economic environment of the
business and may make wrong estimates.
This method is ideal for short term and not for long term forecasting
Subjective Methods of Demand Forecasting
Contd…

Experts’ Opinion Method

i) Group Discussion: (developed by Osborn in 1953) Decisions
may be taken with the help of brainstorming sessions or by structured
discussions.
ii) Delphi Technique: developed by the Rand Corporation at the
beginning of the Cold War, to forecast impact of technology on warfare.
Way of getting repeated opinion of experts without their face to
face interaction.
Consolidated opinions of experts is sent for revised views till
conclusions converge on a point.
Merits
Decisions are enriched with the experience of competent experts.
Firm need not spend time, resources in collection of data by survey.
Very useful when product is absolutely new to all the markets.
Demerits
Experts’ may involve some amount of bias.
With external experts, risk of loss of confidential information to rival firms.
 Subjective Methods of Demand Forecasting
Contd…..

Market Simulation
Firms create “artificial market”, consumers are instructed to shop with some
money. “Laboratory experiment” ascertains consumers’ reactions to changes
in price, packaging, and even location of the product in the shop.
Grabor-Granger test:
Half of members are shown new product to see whether they would actually
buy it at various prices on a random price list and then are shown the existing
product. Other half is shown the existing product first and then the new
product to ascertain if a product would be bought at different prices.
Merits
Market experiments provide information on consumer behaviour regarding
a change in any of the determinants of demand.
Experiments are very useful in case of an absolutely new product.
Demerits
People behave differently when they are being observed.
In Grabor-Granger tests consumers may not quote the price they may pay.
 Subjective Methods of Demand Forecasting
Contd….

Test Marketing
Involves real markets in which consumers actually buy a product without
the consciousness of being observed.
product is actually sold in certain segments of the market, regarded as
the “test market”.
Choice and number of test market(s) and duration of test are very crucial
to the success of the results.
Merits
Most reliable among qualitative methods.
Very suitable for new products.
Considered less risky than launching the product across a wide region.
Demerits
Very costly as it requires actual production of the product, and in event of
failure of the product the entire cost of test is sunk.
Time consuming to observe the actual buying pattern of consumers..
Extrapolation of figures for calculating demand in widely varying markets
across its geographical regions may not give accurate results.
Quantitative Methods of Demand Forecasting

Trend Projection
Statistical tool to predict future values of a variable on
the basis of time series data.
Time series data are composed of:
Secular trend (T): change occurring consistently over a long time
and is relatively smooth in its path.
Seasonal trend (S): seasonal variations of the data within a year
Cyclical trend (C): cyclical movement in the demand for a product
that may have a tendency to recur in a few years
Random events (R): have no trend of occurrence hence they create
random variation in the series.
Additive Form: Y = T + S + C + R………..(1)
Multiplicative Form: Y = T.S.C.R………….(2)
Log Y= log T + log S + log C + log R………….(3)
 Quantitative Methods:
Methods of Trend Projection
Contd…
Graphical method
Past values of the variable on vertical axis and time on horizontal
axis and line is plotted.
Movement of the series is assessed and future values of the variable
are forecasted
simple but provides a general indication and fails to predict future value
of demand

200
180
160
Demand for mobiles (in lakhs)

140
120
100
80
60
40
20
0
2001 2002 2003 2004 2005
Ye a r
Quantitative Methods:
Methods of Trend Projection Contd…

Least squares method

based on the minimization of squared deviations between the best
fitting line and the original observations given.
Estimates coefficients of a linear function.
Y=a+bX where a =intercept
and b =slope
The normal equations:
ΣY=na + bΣX
ΣXY= aΣX+ bΣX2
Once the coefficients of the trend equation are estimated, we can
easily project the trend for future periods.
Solving the normal equations:

a= Y  bX
(Y  Y )(X  X )
b= å( X  X ) 2
Quantitative Methods :
Smoothing Techniques
Moving Average: forecasts on the basis of demand values
during the recent past.
n

åDi
i1

Dn= n where Di= demand in the ith period, n= number of periods in the

moving average
Weighted Moving Average: forecast the future value of sales
on the basis of weights given to the most recent observations. The
formula for computing weighted moving average is given as:
n wD
åi i
Dn= i1 where Di= demand in the ith period, wi= weight for the ith

period, n= number of periods in the moving average.

Quantitative Methods :
Smoothing Techniques Contd…

Exponential Smoothing: assign greater weights to the

most recent data, in order to have a more realistic estimate
of the fluctuations. Weights usually lay between zero and
one
Ft+1=aDt+(1-a)Ft
where Dt+1= forecast for the next period, D t=actual demand in the
present period, Ft=previously determined forecast for the present
period, and a=weighting factor, termed as smoothing constant.
Quantitative Methods :
Barometric Techniques Contd….

Barometric Technique alerts businesses to changes in the

overall economic conditions.
Helps in predicting future trends on the basis of index of
relevant economic indicators especially when the past data
do not show a clear tendency of movement in a particular
direction.
Indicators may be
Leading indicators: economic series that typically go up or down
ahead of other series
Coincident indicators: move up or down simultaneously with the
level of economic activities
Lagging series : which moves with economic series after a
time lag.
Quantitative Methods
Contd…..
Simple (or Bivariate) Regression Analysis:
deals with a single independent variable that determines the value
of a dependent variable.
Demand Function: D = a+bP, where b is negative.
If we assume there is a linear relation between D and P,
there may also be some random variation in this relation.
Sum of Squared Errors (SSE) : a measure of the predictive accuracy
Smaller the value of SSE, the more accurate is the regression equation.
Quantitative Methods
Contd…..

Multiple Regression Analysis:

D = a1+a2.P+a3.A+e
(where A = advertising expenditure incurred).
D^ = a^1 + a^2P + a^3A,
(where a1, a2 and a3 are the parameters and e is the random error
term (or disturbance), having zero mean).
Similar to simple regression analysis, multiple regression
analysis would aim at estimation of the parameters a1,
a2 and a3.
Choose such values of the coefficients that would
minimize the sum of squares of the deviations.
Limitations of Demand Forecasting

Change in Fashion: Is an inevitable consequence of advancement

of civilization. Results of demand forecasting have short lasting
impacts especially in a dynamic business environment.
Consumers’ Psychology: Results of forecasting depend largely on
consumers’ psychology, understanding which itself is difficult.
Uneconomical: Requires collection of data in huge volumes and
their analysis, which may be too expensive for small firms to afford.
Estimation process may take a lot of time, which may not be
affordable.
Lack of Experienced Experts: Accurate forecasting necessitates
experienced experts, who may not be easily available. Forecasting
by less experienced individuals may lead to erroneous estimates.
Lack of Past Data: Requires past sales data, which may not be
correctly available. Typical problem in case for a new product.