BBA-I & BCCA-II_BusinessEconomics_DemandForecasting

DEMAND FORECASTING

Introduction:

Today business enterprises are working under the conditions of uncertainties. Uncertainties can be minimized through planning and forecasting. The success of a business firm depends upon its ability to forecast future events.

Meaning of Demand Forecasting:

Future is uncertain. There is great deal of uncertainty with regard to demand. Since the demand is uncertain, production, cost, revenue, profit etc. are also uncertain. Through forecasting it is possible to minimize the uncertainties.

Forecasting simply refers to estimating or anticipating future events. It is an attempt to foresee the future by examining the past. Thus demand forecasting means estimating or anticipating future demand on the basis of past data.

Objectives of Demand Forecasting:

A. Short Term Objectives

1. To help in preparing suitable sales and production policies.

2. To help in ensuring a regular supply of raw materials.

3. To reduce the cost of purchase and avoid unnecessary purchase.

4. To ensure best utilization of machines.

5. To make arrangements for skilled and unskilled workers so that suitable labour

    force may be maintained.

6. To help in the determination of a suitable price policy.

7. To determine financial requirements.

8. To determine separate sales targets for all the sales territories.

9. To eliminate the problem of under or over production.

B. Long term Objectives

1. To plan long term production.

2. To plan plant capacity.

3. To estimate the requirements of workers for long period and make arrangements.

4. To determine an appropriate dividend policy.

5. To help the proper capital budgeting.

6. To plan long term financial requirements.

7. To forecast the future problems of material supplies and energy crisis.

Factors Affecting Demand Forecasting:

For making a good forecast, it is essential to consider the various factors governing demand forecasting. These factors are summarized as follows.

1. Prevailing business conditions: While preparing demand forecast it becomes necessary to study the general economic conditions very carefully. These include the price level changes, change in national income, per-capita income, consumption pattern, savings and investment habits, employment etc.

2. Conditions within the industry: Every business enterprise is only a unit of a particular industry. Sales of that business enterprise are only a part of the total sales of that industry. Therefore, while preparing demand forecasts for a particular business enterprise, it becomes necessary to study the changes in the demand of the whole industry, number of units within the industry, design and quality of product, price policy, competition within the industry etc.

3. Conditions within the firm: Internal factors of the firm also affect the demand forecast. These factors include plant capacity of the firm, quality of the product, price of the product, advertising and distribution policies, production policies, financial policies etc.

4. Factors affecting export trade: If a firm is engaged in export trade also it should consider the factors affecting the export trade. These factors include import and export control, terms and conditions of export, exim policy, export conditions, export finance etc.

5. Market behavior : While preparing demand forecast, it is required to consider the market behavior which brings about changes in demand.

6. Sociological conditions: Sociological factors have their own impact on demand forecast of the company. These conditions relate to size of population, density, change in age groups, size of family, family life cycle, level of education, family income, social awareness etc.

7. Psychological conditions: While estimating the demand for the product, it becomes necessary to take into consideration such factors as changes in consumer tastes, habits, fashions, likes and dislikes, attitudes, perception, life styles, cultural and religious bents etc.

8. Competitive conditions: The competitive conditions within the industry may change. Competitors may enter into market or go out of market. A demand forecast prepared without considering the activities of competitors may not be correct.

Process of Demand Forecasting/ Steps in Demand Forecasting:

Demand forecasting involves the following steps:

1. Determine the purpose for which forecasts are used.

2. Subdivide the demand forecasting programme into small I parts on the basis of

    product or sales territories or markets.

3. Determine the factors affecting the sale of each product and their relative

    importance.

4. Select the forecasting methods.

5. Study the activities of competitors.

6. Prepare preliminary sales estimates after, collecting necessary data.

7. Analyse advertisement policies, sales promotion plans, personal sales

    arrangements etc. and ascertain how far these programmes have been successful

    in promoting the sales.

8. Evaluate the demand forecasts monthly, quarterly, half yearly or yearly and

    necessary adjustments should be done.

9. Prepare the final demand forecast on the basis of preliminary forecasts and the

    results of evaluation.

METHODS OF DEMAND FORECASTING :

There are several methods to predict the future demand. All methods can be broadly classified into two. (A) Survey methods, (B) Statistical methods.

(A) Survey methods

Under this method surveys are conducted to collect information about the future purchase plans of potential consumers. Survey methods help in obtaining information about the desires, likes and dislikes of consumers through collecting the opinion of experts or by interviewing the consumers. Survey methods are used for short term forecasting. Important survey methods are (a) consumers interview method, (b) collective opinion or sales force opinion methodic) experts opinion method, (d) consumers clinic and (f) end use method.

(a) Consumers' interview method (Consumers survey): Under this method, consumers are interviewed directly and asked the quantity they would like to buy. After collecting the data, the total demand for the product is calculated. This is done by adding up all individual demands. Under the consumer interview method, either all consumers or selected few are interviewed. When all the consumers are interviewed, the method is known as complete enumeration method. When only a selected group of consumers are interviewed, it is known as sample survey method.

Advantages

1. It is a simple method because it is not based on past record.

2. It suitable for industrial products.

3. The results are likely to be more accurate.

4. This method can be used for forecasting the demand of a new product.

Disadvantages

1. It is expensive and time consuming.

2. Consumers may not give their secrets or buying plans.

3. This method is not suitable for long term forecasting.

4. It is not suitable when the number of consumer is large.

(b)Collective opinion method: Under this method the salesmen estimate the expected sales in their respective territories on the basis of previous experience. Then demand is estimated after combining the individual forecasts (sales estimates) of the salesmen. This method is also known as sales force opinion method.

Advantages

This method is simple.

1. It is based on the first hand knowledge of Salesmen.

2. This method is particularly useful for estimating demand of new products.

3. It utilizes the specialized knowledge of salesmen who are in close touch with the

   prevailing market conditions.

Disadvantages

1. The forecasts may not be reliable if the salespeople are not trained.

2. It is not suitable for long period estimation.

3. It is not flexible.

4. Salesmen may give lower estimates that make possible easy achievement of sales

quotas fixed for each salesman.

(c)Experts' opinion method: This method was originally developed at Rand Corporation in 1950 by Olaf Helmer Dalkey and Gordon. Under this method, demand is estimated on the basis of opinions of experts and distributors other than salesmen and ordinary consumers. This method is also known as Delphi method. Delphi is the ancient Greek temple where people come and prey for information about their future.

Advantages

1. Forecast can be made quickly and economically

2. This is a reliable method because estimates are made on the basis of knowledge

and experience of sales experts.

3. The firm need not spare its time on preparing estimates of demand.

4. This method is suitable for new products.

Disadvantages

1. This method is expensive.

2. This method sometimes lacks reliability

(d)Consumer clinics: In this method some selected buyers are given certain amounts of money and asked to buy the products. Then the prices are changed and the consumers are asked to make fresh purchases with the given money. In this way the consumers" responses to price changes are observed. Thus the behavior of the consumers is studied.

On this basis demand is estimated. This method is an improvement over consumer’s

interview method.

Merits

1. It provides an opportunity to study the behavior of consumers directly.

2. It provides reliable and realistic picture about future demand.

3. It gives useful information to aid in the decision making process.

Demerits

1. It is a time consuming method.

2. Selecting the participants is very difficult.

3. It is expensive.

4. Consumers may take it as a game. They may not reveal their preferences.

(e) End use method: This method is based on the fact that a product generally has different uses. In the end use method, first a list of end users (final consumers, individual industries, exporters etc.) is prepared. Then the future demand for the product is found either directly from the end users or indirectly by estimating their future growth. Then the demand of all end users of the product is added to get the total demand for the product.

Statistical Methods

Statistical methods use the past data as a guide for knowing the level of future demand. Statistical methods are generally used for long run forecasting. These methods are used for established products. Statistical methods include: (i) Trend projection method, (ii) Regression and Correlation, (iii) Extrapolation method, (iv) Simultaneous equation method, and (v) Barometric method.

(i)Trend projection method: Future sales are based on the past sales, because future is the grand-child of the past and child of the present. Under the trend projection method demand is estimated on the basis of analysis of past data. This method makes use of time series (data over a period of time). We try to ascertain the trend in the time series. The trend in the time series can be estimated by using any one of the following four methods:

(a) Least-square method, (b) Free-hand method, (c) Moving average method and (d)

semi-average method.

(ii) Regression and Correlation: These methods combine economic theory and statistical technique of estimation. Under these methods the relationship between the sales (dependent variable) and other variables (independent variables such as price of related goods, income, advertisement etc.) is ascertained. Such relationship established on the basis of past data may be used to analyse the future trend. The regression and correlation analysis is also called the econometric model building.

(iii) Extrapolation: Under this statistical method, the future demand can be extrapolated by applying Binomial expansion method. This method is used on the assumption that the rate of charge in demand in the past has been uniform.

(iv) Simultaneous equation method.-This involves the development of a complete econometric model which can explain the behavior of all the variables which the company can control. This method is not very popular.

(v) Barometric technique: This is an improvement over the trend projection method. According to this technique the events of the present can be used to predict the directions of change m the future. Here certain economic and statistical indicators from the selected time series are used to predict variables. Personal income, non-agricultural placements, gross national income, prices of industrial materials, wholesale commodity prices, industrial production, bank deposits etc. are some of the most commonly used indicators.

Advantages of Statistical Methods:

1 The method of estimation is scientific

2 Estimation is based on the theoretical relationship between sales (dependent

variable) and price, advertising, income etc. (independent variables)

3 These are less expensive.

4 Results are relatively more reliable.

Disadvantages of Statistical Methods

1 These methods involve complicated calculations.

2 These do not rely much on personal skill and experience.

3 These methods require considerable technical skill and experience in order to be

effective.

Methods of Demand Forecasting for New Products:

Demand forecasting of new product is more difficult than forecasting for existing. The reason is that the product is not available. Hence, no historical data are available. In these conditions the forecasting is to be done by taking into consideration the inclination and wishes of the customers to purchase. For this a research is to be conducted. But there is one problem that it is difficult for a customer to say anything without seeing and using the product before. Thus it is very difficult to forecast the demand for new products. Any way Prof. Joel Dean has suggested the following methods for forecasting demand of new products:

1. Evolutionary approach: This method is based on the assumption that the new product is the improvement and evolution of the old product. The demand is forecasted on the basis of the demand of the old product. For example, the demand for black and white TV should be taken in to consideration while forecasting the demand for colour TV sets because the latter is an improvement of the former.

2. Substitute approach: Here the new product is treated as a substitute of an existing product, e.g. polythene bags for cloth bags. Thus the demand for a new product is analysed as a substitute for some existing goods or service.

3. Growth curve approach: Under this method the growth rate of demand of a new product is estimated on the basis of the growth rate of demand of an existing product. Suppose Pears soap is in use and a new cosmetic is to be introduced in the market. In this case the average sale of Pears soap will give an idea as to how the new cosmetic will be accepted by the consumers.

4. Opinion poll approach: Under this method the demand for a new product is estimated on the basis of information collected from the direct interviews (survey) with consumers.

5. Sales Experience approach: Under this method, the new product is offered for sale in a sample market, i.e. by direct mail or through multiple shop or departmental shop. From this the total demand is estimated for the whole market.

6. Vicarious approach: This method consists of surveying consumers' reactions through the specialized dealers who are in touch with consumers. The dealers are able to know as to how the customers will accept the new product. On the basis of their reports demand can be estimated. The above methods are not mutually exclusive. It is desirable to use a combination of two or more methods in order to get better results.