Demand Forecasting: Meaning, Need, Objectives and Methods7th February 2020
Some of the popular definitions of demand forecasting are as follows:
According to Evan J. Douglas, “Demand estimation (forecasting) may be defined as a process of finding values for demand in future time periods.”
In the words of Cundiff and Still, “Demand forecasting is an estimate of sales during a specified future period based on proposed marketing plan and a set of particular uncontrollable and competitive forces.”
Demand forecasting enables an organization to take various business decisions, such as planning the production process, purchasing raw materials, managing funds, and deciding the price of the product. An organization can forecast demand by making own estimates called guess estimate or taking the help of specialized consultants or market research agencies.
Need of Demand Forecasting
Demand plays a crucial role in the management of every business. It helps an organization to reduce risks involved in business activities and make important business decisions. Apart from this, demand forecasting provides an insight into the organization’s capital investment and expansion decisions.
(i) Fulfilling objectives
Implies that every business unit starts with certain pre-decided objectives. Demand forecasting helps in fulfilling these objectives. An organization estimates the current demand for its products and services in the market and move forward to achieve the set goals.
For example, an organization has set a target of selling 50, 000 units of its products. In such a case, the organization would perform demand forecasting for its products. If the demand for the organization’s products is low, the organization would take corrective actions, so that the set objective can be achieved.
(ii) Preparing the budget
Plays a crucial role in making budget by estimating costs and expected revenues. For instance, an organization has forecasted that the demand for its product, which is priced at Rs. 10, would be 10, 00, 00 units. In such a case, the total expected revenue would be 10* 100000 = Rs. 10, 00, 000. In this way, demand forecasting enables organizations to prepare their budget.
(iii) Stabilizing employment and production
Helps an organization to control its production and recruitment activities. Producing according to the forecasted demand of products helps in avoiding the wastage of the resources of an organization. This further helps an organization to hire human resource according to requirement. For example, if an organization expects a rise in the demand for its products, it may opt for extra labor to fulfill the increased demand.
(iv) Expanding organizations
Implies that demand forecasting helps in deciding about the expansion of the business of the organization. If the expected demand for products is higher, then the organization may plan to expand further. On the other hand, if the demand for products is expected to fall, the organization may cut down the investment in the business.
(v) Taking Management Decisions
Helps in making critical decisions, such as deciding the plant capacity, determining the requirement of raw material, and ensuring the availability of labor and capital.
(vi) Evaluating Performance
Helps in making corrections. For example, if the demand for an organization’s products is less, it may take corrective actions and improve the level of demand by enhancing the quality of its products or spending more on advertisements.
(vii) Helping Government
Enables the government to coordinate import and export activities and plan international trade.
Objectives of short term demand forecasting
- Production policy: Short-term demand forecasting is used to evolve a suitable production policy which can avoid the problems of over production and short supply.
- Expenditure pattern: It helps the firm in purchasing. Knowledge of near future economic conditions help the firm in reducing costs of purchasing raw materials and controlling inventory.
- Sales policy: Demand forecasting helps the firm in evolving a suitable sales policy.
- Price policy: Sales forecasting is useful in determining pricing policy. When the market conditions are expected to be weak, the firm can avoid an increase in price and vice-versa.
- Sales targets, controls and incentives: Short term demand forecasting is used to set sales targets and for establishing controls and incentives.
- Financial requirements: It is useful in forecasting short term financial requirements. Cash requirement depends on production and sales levels. Hence sales forecasts help the firm to make arrangements for necessary funds well in advance.
Objectives of long term demand forecasting
- New unit or expansion: Long term demand forecasting helps in planning of a new unit or expansion of an existing unit of a business organization.
- Financial requirements: It is useful in long term financial planning. Long-term sales forecast is necessary to estimate long term financial requirements.
- Man power planning: Long term demand forecasting enables the firm to make arrangements for training and personnel development. Demand forecasting is also useful to the Government in determining import and export policies.
Objectives Of Demand Forecasting In Business Economics is well recognized by the business organizations who want to produce goods at optimum level. The objectives of short-term demand forecasting are different from those of long term demand forecasting.
Methods of Demand Forecasting
There is no easy or simple formula to forecast the demand. Proper judgment along with the scientific formula is needed to correctly predict the future demand for a product or service. Some methods of demand forecasting are discussed below:
- Survey of Buyer’s Choice
When the demand needs to be forecasted in the short run, say a year, then the most feasible method is to ask the customers directly that what are they intending to buy in the forthcoming time period. Thus, under this method, the potential customers are directly interviewed. This survey can be done in any of the following ways:
- Complete Enumeration Method: Under this method, nearly all the potential buyers are asked about their future purchase plans.
- Sample Survey Method: Under this method, a sample of potential buyers is chosen scientifically and only those chosen are interviewed.
- End-use Method: It is especially used for forecasting the demand of the inputs. Under this method, the final users i.e. the consuming industries and other sectors are identified. The desirable norms of consumption of the product are fixed, the targeted output levels are estimated and these norms are applied to forecast the future demand of the inputs.
Hence, it can be said that under this method the burden of demand forecasting is on the buyer. However, the judgments of the buyers are not completely reliable and so the seller should take decisions in the light of his judgment also.
The customer may misjudge their demands and may also change their decisions in the future which in turn may mislead the survey. This method is suitable when goods are supplied in bulk to industries but not in the case of household customers.
- Collective Opinion Method
Under this method, the salesperson of a firm predicts the estimated future sales in their region. The individual estimates are aggregated to calculate the total estimated future sales. These estimates are reviewed in the light of factors like future changes in the selling price, product designs, changes in competition, advertisement campaigns, the purchasing power of the consumers, employment opportunities, population, etc.
The principle underlying this method is that as the salesmen are closest to the consumers they are more likely to understand the changes in their needs and demands. They can also easily find out the reasons behind the change in their tastes.
Therefore, a firm having good sales personnel can utilize their experience to predict the demands. Hence, this method is also known as Salesforce opinion or Grassroots approach method. However, this method depends on the personal opinions of the sales personnel and is not purely scientific.
- Barometric Method
This method is based on the past demands of the product and tries to project the past into the future. The economic indicators are used to predict the future trends of the business. Based on the future trends, the demand for the product is forecasted. An index of economic indicators is formed. There are three types of economic indicators, viz. leading indicators, lagging indicators, and coincidental indicators.
The leading indicators are those that move up or down ahead of some other series. The lagging indicators are those that follow a change after some time lag. The coincidental indicators are those that move up and down simultaneously with the level of economic activities.
- Market Experiment Method
Another one of the methods of demand forecasting is the market experiment method. Under this method, the demand is forecasted by conducting market studies and experiments on consumer behavior under actual but controlled, market conditions.
Certain determinants of demand that can be varied are changed and the experiments are done keeping other factors constant. However, this method is very expensive and time-consuming.
- Expert Opinion Method
Usually, the market experts have explicit knowledge about the factors affecting the demand. Their opinion can help in demand forecasting. The Delphi technique, developed by Olaf Helmer is one such method.
Under this method, experts are given a series of carefully designed questionnaires and are asked to forecast the demand. They are also required to give the suitable reasons. The opinions are shared with the experts to arrive at a conclusion. This is a fast and cheap technique.
- Statistical Methods
The statistical method is one of the important methods of demand forecasting. Statistical methods are scientific, reliable and free from biases. The major statistical methods used for demand forecasting are:
- Trend Projection Method: This method is useful where the organization has sufficient amount of accumulated past data of the sales. This date is arranged chronologically to obtain a time series. Thus, the time series depicts the past trend and on the basis of it, the future market trend can be predicted. It is assumed that the past trend will continue in future. Thus, on the basis of the predicted future trend, the demand for a product or service is forecasted.
- Regression Analysis: This method establishes a relationship between the dependent variable and the independent variables. In our case, the quantity demanded is the dependent variable and income, the price of goods, price of related goods, the price of substitute goods, etc. are independent variables. The regression equation is derived assuming the relationship to be linear. Regression Equation: Y = a + bX. Where Y is the forecasted demand for a product or service.
Forecasting has the following benefits:
1. Future oriented:
It enables managers to visualize and discount future to the present. It, thus, improves the quality of planning. Planning is done for future under certain known conditions and forecasting helps in knowing these conditions. It provides knowledge of planning premises with which managers can analyse their strengths and weaknesses and take action to meet the requirements of the future market.
For example, if the TV manufacturers feel that LCD or Plasma televisions will replace the traditional televisions, they should take action to either change their product mix or start manufacturing LCD/Plasma screens. Forecasting, thus, helps in utilizing resources in the best and most profitable business areas.
In the fast changing technological world, businesses may find it difficult to survive if they do not forecast customers’ needs and competitors’ moves.
2. Identification of critical areas:
Forecasting helps in identifying areas that need managerial attention. It saves the company from incurring losses because of bad planning or ill defined objectives. By identifying critical areas of management and forecasting the requirement of different resources like money, men, material etc., managers can formulate better objectives and policies for the organisation. Forecasting, thus, increases organisational and managerial efficiency in terms of framing and implementing organisational plans and policies.
3. Reduces risk:
Though forecasting cannot eliminate risk, it reduces it substantially by estimating the direction in which environmental factors are moving. It helps the organisation survive in the uncertain environment by providing clues about what is going to happen in future.
If managers know in advance about changes in consumer preferences, they will bring required modifications in their product design in order to meet the changed expectations of the consumers. Thus, forecasting cannot stop the future changes from happening but it can prepare the organisations to face them when they occur or avoid them, if they can.
Forecasting involves participation of organisational members of all departments at all levels. It helps in coordinating departmental plans of the organisation at all levels. People in all departments at all levels are actively involved in coordinating business operations with likely future changes predicted as a result of forecasting. Thus, forecasting helps in movement of all the plans in the same direction.
5. Effective management:
By identifying the critical areas of functioning, managers can formulate sound objectives and policies for their organisations. This increases organisational efficiency, effectiveness in achieving the plans, better management and effective goal attainment.
6. Development of executives:
Forecasting develops the mental, conceptual and analytical abilities of executives to do things in planned, systematic and scientific manner. This helps to develop management executives.