DEMAND FORECASTING - Its Meaning, Types & Methods

Meaning of Demand Forecasting

Demand forecasting is the activity of estimating the quantity of a product or service that consumers will purchase. Demand forecasting involves techniques including both informal methods, such as educated guesses, and quantitative methods, such as the use of historical sales data or current data from test markets. Demand forecasting may be used in making pricing decisions, in assessing future capacity requirements, or in making decisions on whether to enter a new market.

Methods of Forecasting:

Demand forecasting is a highly complicated process as it deals with the estimation of future demand. It requires the assistance and opinion of experts in the field of sales management. Demand forecasting, to become more realistic should consider the two aspects in a balanced manner. Application of commonsense is needed to follow a pragmatic approach in demand forecasting.

Broadly speaking, there are two methods of demand forecasting.

They are:
1) Survey methods and
2) Statistical methods Figure: Methods of Demand Forecasting

1) Survey Methods:

Survey methods help us in obtaining information about the future purchase plans of potential buyers through collecting the opinions of experts or by interviewing the consumers. These methods are extensively used in short run and estimating the demand for new products. There are different approaches under survey methods. They are
1. Consumers interview method:
Under this method, efforts are made to collect the relevant information directly from the consumers with regard to their future purchase plans. In order to gather information from consumers, a number of alternative techniques are developed from time to time. Among them, the following are some of the important ones.

a) Survey of buyer’s intentions or preferences:

Under this method, consumer-buyers are requested to indicate their preferences and willingness about particular products. They are asked to reveal their ‘future purchase plans with respect to specific items.

b) Direct Interview Method:

Under this method, customers are directly contacted and interviewed. Direct and simple questions are asked to them.

i. Complete enumeration method:

Under this method, all potential customers are interviewed in a particular city or a region.

ii. Sample survey method or the consumer panel method:

Under this method, different cross sections of customers that make up the bulk of the market are carefully chosen. Only such consumers selected from the relevant market through some sampling method are interviewed or surveyed.
2. Collective opinion method or opinion survey method:
Under this method, sales representatives, professional experts and the market consultants and others are asked to express their considered opinions about the volume of sales expected in the future.
3. Delphi Method or Experts Opinion Method:
Under this method, outside experts are appointed. They are supplied with all kinds of information and statistical data. The management requests the experts to express their considered opinions and views about the expected future sales of the company.
4. End Use or Input – Output Method:
Under this method, the sale of the product under consideration is projected on the basis of demand surveys of the industries using the given product as an intermediate product.

2) Statistical Method:

It is the second most popular method of demand forecasting. It is the best available technique and most commonly used method in recent years. Under this method, statistical, mathematical models, equations etc are extensively used in order to estimate future demand of a particular product. They are used for estimating long term demand. They are highly complex and complicated in nature.

A. Trend Projection Method:
An old firm operating in the market for a long period will have the accumulated previous data on either production or sales pertaining to different years. If we arrange them in chronological order, we get what is called „time series This method is not based on any particular theory as to what causes the variables to change but merely assumes that whatever forces contributed to change in the recent past will continue to have the same effect. On the basis of time series, it is possible to project the future sales of a company.
B. Economic Indicators:
Under this method, a few economic indicators become the basis for forecasting the sales of a company. An economic indicator indicates change in the magnitude of an economic variable. It gives the signal about the direction of change in an economic variable. This helps in decision making process of a company.

TYPES OF DEMAND FORECASTING

From the point of the view of the time span and from the planning requirements of business firms, demand forecasting can be classified under two headings

(i) Short-term demand forecasting, and

 (2) Long-term demand forecasting.

SHORT–TERM FORECASTING

Short-term forecasting is limited to short periods, usually not exceeding an year. It relates to policies,regarding sales, purchasing, pricing and finances. Hence the reference is only to the exi-sting production capacity of the firm. In most companies, a knowledge of conditions in the immediate future is essential for formulating a suitable sales policy-production schedules have to be geared to expected rather than actual sales .Often, but assuming that prevailing conditions will continue, a firm may find itself faced with a problem of over production or short supply. An understanding of near future prospects would make it possible to avoid some of the violent fluctuations which occur in production scheduling and sales planning. Knowledge of immediate future conditions is important in pricing. If prices of materials are expected to go up or shortage are expected, businessman may take advantage of the rise by earlier buying. Proper price forecasting may, thus help the firm in reducing the cost of operation. Demand forecasting is also useful to the businessman in determining his price policy. An increase of prices is avoided when future market conditions are not expected to be good and the lowering of prices is avoided when costs or sales levels are likely to rise considerably. Many companies use forecasting for setting sales targets and for establishing controls and incentives. Sales targets will not accomplish their objectives if not geared meaningfully to the sales levels likely to be achieved. If set too high, the targets will be discouraging to those who have to meet them. If the targets are very low, they will be met very easily and incentives will prove meaningless.. In the preparation of budgets, therefore, shot-term forecasts have come to play an important part.

LONG TERM FORECASTING

In short-term forecasting a company is concerned only about the use of its existing production capacity. But when questions of long-term planning are involved the businessman must know something about the long-term demand for this product. Thus the planning of a new production, unit or the expansion of an existing unit must start with an analysis of the long-term demand potential of the products. A multi-product firm must ascertain not only the total demand situation, but also the demand for different items. This will involve the study of consumer preferences and trends, the economy, and technological developments and trends. Once the demand potential is assessed, it will be easier for the company to engage in long-term financial planning. Again manpower planning for existing as well as new firms must be based on long-term forecasts of the company’s growth. When forecasts covering long periods are made, the probability of error is high. Competent forecasts predict he conditions that are likely to prevail in the near future with comparative confidence, and with a relatively high degree of accuracy; the results are much less reliable when they attempt to forecast conditions over longer periods. This is because, as the period becomes longer certain factors that forecaster’s take into account in making their estimates becomes more volatile. It is very difficult to predict over extended periods such items as the probable costs of production, the trend of prices and the changing nature of competition. Moreover the longer the term covered by the prediction, the more likely it is that unanticipated events such as international conflicts including wars, periods of major depression and prosperity and inventions and technological advances will upset the calculation. It is function of the top management in each firm to make it own decision regarding the span of time to be covered by demand forecast. It is safer to forecast for longer periods, when the volume of demand has held fairly constant from year to year. If demand has been erratic for reasons that are largely unexplainable, the forecasting period should be shorter.