Chapter VIChapter VIDemand ForecastingDemand Forecasting

Dr. Gopalakrishna B.V,Dr. Gopalakrishna B.V,Faculty in MBA,Faculty in MBA,

SDM College,SDM College,

IntroductionIntroductionDemand forecasting is the backbone of any Demand forecasting is the backbone of any business. Demand forecasting means the business. Demand forecasting means the estimation or prediction of future demandestimation or prediction of future demand for for goods and services.goods and services.Accurate demand forecasting is essential for a Accurate demand forecasting is essential for a firm to produced required quantities at the right firm to produced required quantities at the right time & arrange well in advance for the various time & arrange well in advance for the various factors of production viz., raw-materials, factors of production viz., raw-materials, equipment, machine accessories, labour and equipment, machine accessories, labour and building etc.building etc.Some firms may as a policy produce to order Some firms may as a policy produce to order but, generally, firms produce in anticipation of but, generally, firms produce in anticipation of future demand.future demand.Forecasting is an important aid in effective and Forecasting is an important aid in effective and efficient planning. efficient planning.

Demand forecasting is also helpful in better Demand forecasting is also helpful in better planning and allocation of natural resources.planning and allocation of natural resources.Demand forecasting is very popular in Demand forecasting is very popular in industrially advanced countries where demand industrially advanced countries where demand conditions are always more uncertain than conditions are always more uncertain than supply conditions.supply conditions.Developing economy, instead of the demand, Developing economy, instead of the demand, supply is often the limited factor – due to high supply is often the limited factor – due to high prices and block markets – supply bottlenecks.prices and block markets – supply bottlenecks.In India supply forecasting seems to be more In India supply forecasting seems to be more important than demand forecasting.important than demand forecasting.The impact of New Economic Policy – relaxation The impact of New Economic Policy – relaxation of industrial Licensing regulations and economic of industrial Licensing regulations and economic liberalisation – increasing competition, change liberalisation – increasing competition, change the situation in India as well. the situation in India as well.

The level of demand forecastingThe level of demand forecasting

1.1. Micro levelMicro level – demand forecasting by – demand forecasting by individual business firm for forecasting the individual business firm for forecasting the demand for its product.demand for its product.

2.2. Industrial levelIndustrial level – demand estimate for the – demand estimate for the product of the industry – it obviously, product of the industry – it obviously, undertaken by Industrial or Trade undertaken by Industrial or Trade Association.Association.

3.3. Macro levelMacro level – aggregate demand forecasting – aggregate demand forecasting for industrial output at the national level – it for industrial output at the national level – it is based on the national income/aggregate is based on the national income/aggregate expenditure of the country. expenditure of the country.

Types of Demand ForecastingTypes of Demand Forecasting

Demand Forecasting

Short term forecasting Long term forecasting

Types of Demand ForecastingTypes of Demand Forecasting1. Short term forecasting 1. Short term forecasting

short term demand forecasting refers to a period short term demand forecasting refers to a period of one year of one year not exceeding a yearnot exceeding a year..

When the demand for its products is changing When the demand for its products is changing very frequently.very frequently.

2. Long term forecasting2. Long term forecasting refers to the forecasts prepared for long period refers to the forecasts prepared for long period

during which, the firms during which, the firms scale of production scale of production capacity may be expanded/reduced.capacity may be expanded/reduced.

Long term forecasting, normally for the periods Long term forecasting, normally for the periods exceeding a year or 3-4 years or even a decade or exceeding a year or 3-4 years or even a decade or more than 10 year & above. more than 10 year & above.

Purposes of short term forecastingPurposes of short term forecasting

11. Appropriate production schedule. Appropriate production schedule to avoid the problem of over production & to avoid the problem of over production &

under production.under production. Every firm has to produce goods according to Every firm has to produce goods according to

a pre-estimated production plan.a pre-estimated production plan.

2. Reducing cost of purchasing raw-materials2. Reducing cost of purchasing raw-materials Firm purchasing raw-material at cheaper rates Firm purchasing raw-material at cheaper rates

& controlling inventory.& controlling inventory.

3. Determining appropriate price policy3. Determining appropriate price policy Fix the price as per the market condition.Fix the price as per the market condition. Price does not fluctuate so much during the period of Price does not fluctuate so much during the period of

inflation.inflation.

4. To evolve a proper advertising policy4. To evolve a proper advertising policy It is only through accurate demand estimationIt is only through accurate demand estimation Effective and economical advertisement can be planned by a Effective and economical advertisement can be planned by a

firm.firm.

5. 5. To forecast short term financial requirementsTo forecast short term financial requirements Financial requirement depends on sales level & volume of Financial requirement depends on sales level & volume of

production.production. If the demand is likely to go up in the near future – financial If the demand is likely to go up in the near future – financial

facilities are also increases and vice-versa.facilities are also increases and vice-versa.

Purposes of long-term forecastingPurposes of long-term forecasting

1.1. Planning of a new unit or expansion of an Planning of a new unit or expansion of an existing unitexisting unit

If the demand is likely to go up in next 10-15 years If the demand is likely to go up in next 10-15 years expansion of the existing units or set up new units.expansion of the existing units or set up new units.

2. To plan for man-power requirement2. To plan for man-power requirement Training and personnel developments are long term Training and personnel developments are long term

programmes – long time requirement.programmes – long time requirement.

3. To plan for long term financial requirements3. To plan for long term financial requirements Big investments projects require a large amount of Big investments projects require a large amount of

finance – 10 -15 -20 years – infrastructure finance – 10 -15 -20 years – infrastructure development.development.

Before understanding such projects it becomes Before understanding such projects it becomes necessary to assess the long term demand necessary to assess the long term demand conditions. conditions.

Factors determines demand forecastingFactors determines demand forecasting

1.1. Time factorTime factor

2.2. Level of forecastingLevel of forecasting

3.3. General or Specific forecastingGeneral or Specific forecasting

4.4. Problems & methods of forecastingProblems & methods of forecasting

5.5. Classification of goodsClassification of goods

6.6. Knowledge of different market conditionsKnowledge of different market conditions

7.7. Other factorsOther factors

1. Time factor1. Time factor Demand forecasting has to be made for both short Demand forecasting has to be made for both short

and long periods.and long periods. It all depends on the nature of the commodity – Ice-It all depends on the nature of the commodity – Ice-

creams, umbrellas etc – short period, while, in the creams, umbrellas etc – short period, while, in the case of cement, iron & steel etc long period case of cement, iron & steel etc long period forecasting is desirable.forecasting is desirable.

2. Level of Forecasting2. Level of Forecasting Demand forecasting may be undertaken at three Demand forecasting may be undertaken at three

levels firm level, industry level and macro levellevels firm level, industry level and macro level Firm levelFirm level – concerned with particular firm – concerned with particular firm Industry levelIndustry level – different industry/ trade association – different industry/ trade association Macro levelMacro level – forecasting of business conditions in – forecasting of business conditions in

the entire economy.the entire economy.

3. General or Specific forecasting3. General or Specific forecasting If the forecasting is undertaken generally or If the forecasting is undertaken generally or

total by a firm – general forecastingtotal by a firm – general forecasting If the firms requires commodity wise or area If the firms requires commodity wise or area

wise forecasting – specific forecasting.wise forecasting – specific forecasting.

4. Problems and methods of forecasting4. Problems and methods of forecasting Methods & problems of forecasting the demand Methods & problems of forecasting the demand

for new products are different from old or for new products are different from old or established products.established products.

The old/established product is not at all so The old/established product is not at all so difficult to estimate future demand.difficult to estimate future demand.

While – it is very difficult to forecast the While – it is very difficult to forecast the demand for new product.demand for new product.

5. Classification of Goods5. Classification of Goods Demand forecasting are depends on the nature of goods – Demand forecasting are depends on the nature of goods –

producer goods & consumer good – durable & non-durable goods producer goods & consumer good – durable & non-durable goods etc.etc.

6. Knowledge of different market conditions6. Knowledge of different market conditions Demand forecasting is different under different market conditionsDemand forecasting is different under different market conditions Monopoly marketMonopoly market – forecasting is easy, since there are no – forecasting is easy, since there are no

substitutes or competitorssubstitutes or competitors Monopolistic competitionMonopolistic competition – firm has to face much risk as there are – firm has to face much risk as there are

many substitutes. many substitutes.

7. Other factors7. Other factors There are some special factors which must also be taken into There are some special factors which must also be taken into

accountaccount For example – political factors (elections) sociological factors, For example – political factors (elections) sociological factors,

psychology of consumers & pattern of income distribution etc.psychology of consumers & pattern of income distribution etc. Forecasting differs from product to product, time to time & place to Forecasting differs from product to product, time to time & place to

place. place.

Methods of Demand ForecastingMethods of Demand Forecasting

Demand forecasting is a difficult exercise, making Demand forecasting is a difficult exercise, making estimates for future under the estimates for future under the changing conditionschanging conditions is a is a Herculean task.Herculean task.

Consumer’s behaviour is the Consumer’s behaviour is the most unpredictable-most unpredictable- because it is motivated & influenced by a because it is motivated & influenced by a multiplicity of multiplicity of forcesforces. .

There is There is no easy method or a simple formulano easy method or a simple formula which which enables the manager to predict the future.enables the manager to predict the future.

Economists and statisticiansEconomists and statisticians have developed several have developed several methods of demand forecasting.methods of demand forecasting.

Each of there methods have its relative Each of there methods have its relative advantages & advantages & disadvantages.disadvantages.

Selection of the Selection of the right method is essentialright method is essential to make to make demand forecasting accurate.demand forecasting accurate.

In demand forecasting a judicious combination of In demand forecasting a judicious combination of statistical skills & rational judgment needed. statistical skills & rational judgment needed.

ChartChart

Survey MethodSurvey MethodThe survey method are also called as The survey method are also called as direct direct method,method, the information obtain - future demand the information obtain - future demand for goods - through a survey method.for goods - through a survey method.Survey are Survey are important technique for short termimportant technique for short term forecasts.forecasts.This is especially in the case when a firm This is especially in the case when a firm introduce new product into the marketintroduce new product into the market..Survey method generally involve use of Survey method generally involve use of conducting conducting consumer interview/sending mailed consumer interview/sending mailed questionnairesquestionnaires asks consumer about their asks consumer about their intentions of demand for goods.intentions of demand for goods.Generally individual firms/manager make survey Generally individual firms/manager make survey when they are introducing a new product in their when they are introducing a new product in their existing product. existing product.

Opinion Polling MethodOpinion Polling Method

This method is also known as This method is also known as sales-force-sales-force-composite method/collective opinion methodcomposite method/collective opinion method..Under this method, the Under this method, the salesmen have to report salesmen have to report to the head officeto the head office their estimates of expectations their estimates of expectations of sales in their territories.of sales in their territories.Such information can also be obtained from Such information can also be obtained from retailers and wholesalersretailers and wholesalers by the company. by the company.The average value judgment & collective The average value judgment & collective wisdom of top sales executives, marketing wisdom of top sales executives, marketing manager, business//managerial economists all manager, business//managerial economists all together. together.

Export OpinionExport Opinion

Apart from salesmen & consumers, Apart from salesmen & consumers, distributors or distributors or outside expertsoutside experts may also may also be used for forecasting.be used for forecasting.

In USA – automobile companies get sales In USA – automobile companies get sales estimates estimates directly from their dealersdirectly from their dealers. .

Firms in advanced countries make use of Firms in advanced countries make use of outside experts for estimating future outside experts for estimating future demand. demand.

Delphi MethodDelphi Method

Olaf Helmer originated the Delphi method in the Olaf Helmer originated the Delphi method in the late 1940s.late 1940s.A variant of the opinion poll & survey method is A variant of the opinion poll & survey method is called Delphi method.called Delphi method.It is a It is a highly sophisticated statistical method.highly sophisticated statistical method.Under this method, Under this method, a group of experts & a group of experts & repeatedly questioned for their repeatedly questioned for their opinion/commentsopinion/comments on some issues & their on some issues & their agreements & disagreements are clearly agreements & disagreements are clearly identified. identified. It is a It is a time savingtime saving device deviceThe heterogeneous group of experts with The heterogeneous group of experts with different backgroundsdifferent backgrounds

D. Consumers Interview methodD. Consumers Interview method

In this method the consumers are contacted In this method the consumers are contacted personally to know about their plans & personally to know about their plans & preferences regarding the consumption of the preferences regarding the consumption of the product.product.A list of all potential buyers would be drawn & A list of all potential buyers would be drawn & each buyers will be approached & asked how each buyers will be approached & asked how much he plans to buy the listed product in much he plans to buy the listed product in future.future.This method seems to be the most ideal This method seems to be the most ideal method for forecasting demand – This method method for forecasting demand – This method gives first hand information – it is three types gives first hand information – it is three types

1.1. Complete Enumeration MethodComplete Enumeration Method2.2. Sample SurveySample Survey3.3. End – Use MethodEnd – Use Method

1. Complete Enumeration Method1. Complete Enumeration Method all the consumers of the product are interviewed & all the consumers of the product are interviewed &

are asked to inform about future plan of purchasing are asked to inform about future plan of purchasing that product.that product.

2. 2. Sample Survey method Sample Survey method A sample of consumers is selected for interview.A sample of consumers is selected for interview. The sample may be random sampling or stratified The sample may be random sampling or stratified

sampling.sampling. This method is easy, less costly & also highly This method is easy, less costly & also highly

useful.useful.

3. 3. End – Use MethodEnd – Use Method Information about the end use of the product is Information about the end use of the product is

collected from industrial users & others from collected from industrial users & others from different sectors of the economy.different sectors of the economy.

Such as industries, final consumption, export & Such as industries, final consumption, export & imports etc. imports etc.

Statistical MethodStatistical Method

Statistical method is used for long run Statistical method is used for long run forecasting.forecasting.Statistical & mathematical techniques are used Statistical & mathematical techniques are used to forecast demand.to forecast demand.Statistical methods has been used to explain Statistical methods has been used to explain time-series & cross-section data for estimating time-series & cross-section data for estimating long-term demand.long-term demand.Statistical methods are considered to be Statistical methods are considered to be superior techniques of demand estimation.superior techniques of demand estimation.The important statistical methods are –The important statistical methods are –

1.1. Trend Projection method/time seriesTrend Projection method/time series2.2. Barometric methodsBarometric methods3.3. Econometric methodEconometric method

1. Trend project method1. Trend project method

Trend project method are also called as Trend project method are also called as time time series methodseries method – therefore, it is also known as – therefore, it is also known as time series analysis.time series analysis.

The data relating to sales over a period of time The data relating to sales over a period of time is known as time series data (10 – 20 yrs).is known as time series data (10 – 20 yrs).

On the basis of the past trend in demand, On the basis of the past trend in demand, forecasting the future demand trend is possible.forecasting the future demand trend is possible.

Trend project method classified into 3 types –Trend project method classified into 3 types –1.1. Graphical methodGraphical method

2.2. Fitting trend equation/least square method &Fitting trend equation/least square method &

3.3. Box – Jenkins methodBox – Jenkins method

1. Graphical Method1. Graphical Method Annual data on sales are plotted on a graph paper & a Annual data on sales are plotted on a graph paper & a

line is drawn through the plotted points.line is drawn through the plotted points. This method is very simple & less expensive.This method is very simple & less expensive.

2. Fitting Trend Equation2. Fitting Trend Equation A trend line (curve) is fitting to the time-series sales A trend line (curve) is fitting to the time-series sales

data with the aid of statistical techniques.data with the aid of statistical techniques.

3. Box Jenkins Method3. Box Jenkins Method This method of forecasting is used only for short-term This method of forecasting is used only for short-term

predictions.predictions. This method is suitable for forecasting demand with This method is suitable for forecasting demand with

only stationary time series sales data.only stationary time series sales data. Stationary time-series is one which does not reveal a Stationary time-series is one which does not reveal a

log term trend. log term trend.

2. Barometric Method2. Barometric Method Barometric method is an Barometric method is an improvement over improvement over

trend projection method.trend projection method. Under barometric method, present events are Under barometric method, present events are

used to predict the used to predict the directions of change in directions of change in future.future.

This method done with the help of This method done with the help of economic & economic & statistical indicators.statistical indicators.

This method is also known as This method is also known as Economic Economic Indicators MethodsIndicators Methods. Under barometric . Under barometric method, present events are used to predict method, present events are used to predict the directions of change in future. the directions of change in future.

3. Econometric Methods3. Econometric Methods

The econometric methods The econometric methods combine statistical combine statistical tools with economic theoriestools with economic theories to estimate to estimate economic variables & to forecast economic economic variables & to forecast economic events.events.

Demand forecasting made through Demand forecasting made through econometric econometric methods are much more reliablemethods are much more reliable than those than those made through any other method.made through any other method.

The econometric methods are of two types –The econometric methods are of two types –

1. Regression Method1. Regression Method

2. Simultaneous Equations Methods2. Simultaneous Equations Methods

1.1. Regression method –Regression method – Refers to those methods by which the relationship Refers to those methods by which the relationship

between quantity demanded & one or more independent between quantity demanded & one or more independent variable (like – income, price of commodity & variable (like – income, price of commodity & advertisement cost) is estimated.advertisement cost) is estimated.

It consists 2 methods –It consists 2 methods –1. 1. Simple Regression AnalysisSimple Regression Analysis – used when the – used when the

quantity demanded is estimated as a function of a quantity demanded is estimated as a function of a single independent variable such as price.single independent variable such as price.

2. Multiple Regression Analysis2. Multiple Regression Analysis – used to estimate – used to estimate demand as a function of two or more independent demand as a function of two or more independent variablesvariables

2. Simultaneous Equation Method2. Simultaneous Equation Method This method is also known as the complete system This method is also known as the complete system

approach.approach. It involves simultaneous considerations of all variables. It involves simultaneous considerations of all variables.