Demand Forecasting PDF

# Demand Forecasting ## Part 1 - Introduction Production planning is an important aspect of production management. A business firm’s production planning needs answers to how much to produce. A simple easy answer is ‘as much as can be sold’, however, to find out how much can be sold, the business ma...

# Demand Forecasting ## Part 1 - Introduction Production planning is an important aspect of production management. A business firm’s production planning needs answers to how much to produce. A simple easy answer is ‘as much as can be sold’, however, to find out how much can be sold, the business managers are required to estimate and forecast demand. This chapter provides: * The meaning and purpose of demand forecasting * Preliminary steps for demand forecasting * Methods of demand forecasting * Applicability of each method with their advantages and disadvantages ## Part 2 - Meaning and Purpose of Demand Forecasting Demand forecasting is predicting the future demand for a product. This information is essential for planning and implementing production, purchasing raw materials, acquiring finance, and marketing. Demand forecasting is especially important for large-scale enterprises with long-term goals. It helps the business avoid undersupply or oversupply. The question of what the future demand will be is important for every business to consider in order to acquire raw materials, plan production, and establish their products in the market. However, for small firms catering to a small share of the total demand, or those whose product caters to short-term or seasonal demand, or to routine demand - past experience and skills can be sufficient for planning. Large-scale firms face challenges in obtaining information needed to make accurate long-term or even short-term demand forecasts. They are required to make considerations for variable factors like: * Price * Advertisement expenditure * Credit terms * Prices of competing products They also must consider how these factors may affect future demand. It is imperative for large firms to secure at least a rough estimate of future demand to ensure success in planning areas like: * Acquiring inputs * Organizing production * Advertising the product * Organizing sales channels The prior knowledge of market size, therefore, becomes an essential element for decision making by large-scale firms. ## Part 3 - Pre-requisites of Good Demand Forecasting Forecasting demand with high reliability is a challenge, but certain prerequisites for good demand forecasting help to increase the reliability of the forecast. ### Prerequisites: 1. **High Degree of Reliability** - there is not always certainty when forecasting demand. This means that there is a risk of inaccurate results. ## Part 4 - Survey Methods Survey methods are generally used when the purpose is to make short-run forecasts of demand. This method is useful for collecting information about current demand and future purchase plans and includes: 1. **Survey of Potential Consumers** - to collect data on purchase plans. 2. **Opinion Poll of Experts** - an opinion survey of market experts, sales representatives, and market studies. ### Consumer Survey Methods - Direct Interviews The consumer survey method involves direct interviews with the potential consumers. ### Advantages: * The most direct and easiest way to assess future demand. * It is possible to interview all potential consumers or only selected groups of consumers. ### Disadvantages: * Consumers may not know their future demand and may be unwilling to answer questions. * Any responses from consumers may simply be hypothetical and not a true reflection of real demand. * Consumer responses may be biased by their own expectations of market conditions. * Future plans can change and may not be representative of actual consumer behavior. ### Complete Enumeration Method In this method, all potential users of a product are contacted and are asked about their future purchasing plans. ### Advantages: * Most direct and simple way to assess future demand. ### Disadvantages: * It can only be used successfully when consumers are concentrated in a specific area. * It can be challenging to collect data from consumers who have a dispersed market. * This method can be costly in terms of money and time. * The demand forecasts may not be reliable for a number of reasons, such as consumers may not know their true demand or they may simply provide hypothetical answers, their answer is biased by their own expectations of market conditions, or their plans may change based on unforeseen events. ### Sample Survey Method In this method, a small sample of consumers are selected from the relevant market, and a survey or mail questionnaire is sent to them. ### Advantages: * This method is simpler, cheaper, and less time-consuming than the complete enumeration method. * It is commonly used to estimate short-term demand by businesses, government departments, and market study agencies. ### Disadvantages: * Similar to complete enumeration. ### End-Use Method The end-use method is most valuable for forecasting demand for inputs. ### Advantages: * It has considerable theoretical and practical value. * It requires making a schedule of probable aggregate future demand for inputs by industries. ### Disadvantages: * This method is difficult, as it requires a thorough understanding of the product and its uses, and it is important to have access to data in order to make reasonably accurate estimates. **Four Distinct Stages of Estimation:** 1. **Identification of users** - first, identify all the possible users of a product. This is crucial for forecasting demand. 2. **Establishing Norms of Consumption** - establish per unit norms of consumption. This requires setting standards for each use. 3. **Applying Norms** - apply the norms to forecast future demand. This requires obtaining information about future sales, and economic data. 4. **Aggregating Results** - aggregate the results of forecasting demand. **Benefits of this method:** * It is possible to determine the demand for industrial products in great detail by type and size. * It allows you to pinpoint which products are not performing as expected. **Disadvantages:** * Data is difficult to collect from large numbers of users, often located in a dispersed network. * Only relevant and adequate data is acceptable for accuracy. ### Opinion Poll Methods Opinion poll methods collect the opinions of individuals believed to have deep product knowledge. This includes: 1. **Expert-Opinion Method** - Firms with a good network of sales representatives can gather opinions from them to assess the demand for the product. 2. **Delphi Method** 3. **Market Studies and Experiments** ### Expert-Opinion Method Firms having a good network of sales representatives can involve them to assess the demand for the product within their regions and cities. ### Delphi Method This method is employed when different experts in a field are consulted on a topic. ### Market Studies and Experiments Market studies and experiments can provide useful information on consumer behaviour in the marketplace. ### Advantages: * This method is simple and inexpensive. ### Disadvantages: * The accuracy of demand forecasts largely depends on the skill of the market analysts. * It can be difficult to gather accurate information from sales representatives and experts. * Information may be based on a narrow view of the market. ## Part 5 - Statistical Methods Statistical methods are more reliable, accurate, and less subjective. ### Advantages: * They are more reliable and accurate. * Subjectivity is minimized. * The method of estimation is scientific - as it is based on the theoretical relationship between the dependent and independent variables. * They involve lower costs. ### Statistical Methods of Demand Projection Statistical methods include: 1. **Trend Projection Method**. 2. **Barometric Method.** 3. **Econometric Method.** ### Trend Projection Method This method studies the trends in demand over a specific period, assuming that factors responsible for past trends will continue in the future. **Advantages:** * Simple and inexpensive. * Only time-series data is needed. ** Disadvantages:** * It is not very reliable. * It is not appropriate for short-term forecasting. * It doesn't reveal cause-and-effect relationships. * It can be challenging to apply in situations where the trend is cyclical. ### Barometric Method In this method, various economic indicators serve as barometers to forecast trends in business activities. The method was developed in the 1920s but later abandoned due to inaccurate forecasts for the Great Depression. It was later revived, refined and developed further in the 1930s to forecast business cycles. ### Lead-Lag Indicators Lead-lag indicators are used to create an index of economic indicators and forecast trends on the basis of these indicators. They include: 1. **Leading Indicators:** These indicators shift up or down ahead of other economic series. For example, the index of net business or capital formation, new orders for durable goods, new building permits, change in the value of inventories, index of the prices of materials, and corporate profits after tax. 2. **Coincidental Indicators:** These indicators coincide with the level of economic activity. For example, the number of employees in the non-agricultural sector, the rate of unemployment, gross national product at constant prices, sales recorded by the manufacturing, trading and retail sectors. 3. **Lagging Indicators:** These indicators follow changes in other economic series. For example, labor cost per unit of manufactured output, outstanding loans, and lending rate for short-term loans. The time series data on various kinds of indicators are selected on the basis of: 1. The economic significance of the indicator 2. The statistical adequacy of the data. 3. The conformity of the series to overall economic activity. 4. Consistency of the series to the turning points in overall economic activity. 5. The immediate availability of the series. 6. The smoothness of the series. ### Diffusion Indices This approach is used alternately when there is a problem in determining the suitable lead-lag indicators. ### Econometric Methods Econometric methods are statistical tools used to determine economic variables and to forecast them. They are considered to be more reliable than any other method. ### Regression Method This method combines economic theory and statistical techniques to estimate the relationship between the demand for a product and its determinants. This means that economic theory defines the general form of the demand function, and statistical techniques are used to estimate the values of parameters in the estimated equation. ### Single-Variable Demand Functions The demand functions for salt and sugar are dependent on a single variable (population). ### Multi-Variable Demand Functions Demand functions for goods like sweets, fruits, and vegetables are dependent on multiple variables like price, price of substitutes, household income, and population. ### Bivariate Regression Technique In this technique, a single independent variable is used to estimate the value of the dependent variable. ### Multi-variate Regression Technique The demand for a commodity is determined by multiple variables. ### Simultaneous Equations Model This model takes into account the simultaneous interaction between dependent and independent variables. ### Advantages: * More reliable than regression methods * Can be used to forecast the demand for a product, a group of products, or the economy as a whole. ### Disadvantages: * It can be complex and require specialized statistical expertise, especially for large-scale models. ### Applications: * Forecasting demand for a product * Forecasting demand for a group of products * Forecasting the demand for the economy as a whole. ### Conclusion: There are numerous demand forecasting methods available. It is important to select the method that is most appropriate and reliable for the specific needs of each business and the context of a time-series. The reliability of demand forecasting depends not only on the methodology but crucially on how well you understand the product, the market, the business, and the impact of external factors.