Demand Forecasting

- There is a risk and uncertainty in the business environment.

- Firms must decide how much to produce, what price to charge, how much to spend on
advertising, how to expand the business, etc.
- They should be made based on forecasts of the general economic activity and demand for the
firm’s products to reduce the risk and uncertainty.
- Forecasting demand usually begins with a macroeconomic forecast of general economic activity
as the demand for most of the goods and services depends on the economic condition of the
economy.

- Firms use the long-term macro-forecasts (E.g.: GDP and economic growth, changes in the
general price level) of the economy to forecast its long-term growth.
- Also, they use macro-forecasts for their micro-forecasts of the firm’s demand.
- The firm’s demand is usually forecasted based on its historical market share and its planned
marketing strategy.
It is very easy to forecast but if only consider historical patterns of data to forecast, it may be
wrong as present market changes and sudden changes are not included there.
E.g.: Government interventions, current inflation.

- From its general demand forecasts, the firm can forecast its demand by product line.
- These forecasts are used to plan the firm’s operational needs.
E.g.: No of workers, No of machines, No of Raw materials

Objectives of Demand Forecasting

• Reduce risk and uncertainty that the firms face in short-term operational decision making (main)

- Production related decisions (E.g.: To get Raw material, equipment at correct time, we need to
forecast correctly)
- Marketing related decisions (E.g.: Salesforce, distributional network, promotional campaigns)
- Finance related decisions (E.g.: Cash flow, need and cost of outside financing)
- Human resource related decisions

• Reduce risk and uncertainty that the firm faces in planning for long-term growth
E.g.: To consider whether is suitable to expend or merge is based on forecast of demand

Forecasting Techniques

Most of time we use qualitative

techniques in short term.
E.g.: When we consider about the
newly introduced products, there are
no quantitative data are available. So,
we have to us qualitative techniques.
Selection of a Forecasting Technique

Selection of a forecasting technique depends on;

• The cost of preparing the forecast and the benefit that results from its use
Cost – Data collection cost, Data analysis cost, Expert opinion cost, Documentary cost
Benefits – No direct monetary benefits. But can convert to monetary values.
E.g.: Ability to make correct decisions, understand market requirements, understand customers

• The lead time in decision making (How long does it take to get the decision?)
Some techniques take considerable time.

• The time period of the forecast (short-term or long-term)

• The level of accuracy required (100%, 98%, 94%)
• The quality and availability of data
What type of data do we have?

• The level of complexity of the relationships to be forecasted

Some relationships are complex, and some are simple.
E.g.:
- If a firm is in monopoly market is not recently change. Then firm can be forecast on historical
trend. So, the Time Series technique is suitable.
- If a product is in a very competitive market and the market is changing, Time Series technique
is not suitable.

Qualitative Forecasting Techniques

- Qualitative techniques are used to make short-term forecasts when quantitative data are not
available.
- They can also be used for supplementing quantitative techniques.
We are using qualitative techniques. But in some parts, we have to use quantitative techniques.
(Which can’t use qualitative techniques)

- Useful in forecasting demand for products to be newly introduced.

1. Survey techniques
2. Opinion Polls
3. Soliciting foreign perspectives

Survey Techniques
- Economic actors (Businesses, consumers, governments) make economic decisions in advance of
actual expenditures.
- Those intentions can be used to forecast demand through surveys.
E.g.: Surveys of business executives’ plant and equipment expenditure plans
Surveys of plans for inventory changes and sales expectations
Surveys of consumers’ expenditure plans
Value of surveys depend on:
• Skills of those conducting the survey – Accuracy and value of survey depends on the people who
conduct it.
• Un-ambiguity of questions – Some questions are not clear/ open and have different meanings.
• Sample being representative – Should represent population.
• Having a high response rate – how many had answered from the whole group that we have
focused on (80/100 = 80%)
• Being unbiased

Forecasts rarely rely entirely on survey results, rather use them as supplementary information for
decision making.

Disadvantages of Survey Techniques

- May not predict consumer demand with great accuracy during periods of unstable environments
E.g.: Wars
- Consumers will refuse to participate due to
✓ Time consuming nature
✓ Loss of privacy
✓ Pressure from salespeople
- Cost may be high.

Opinion Polls
- Although the results of published surveys of expenditure plans of businesses, consumers, and
governments are useful, the firms usually need specific forecasts of their own demand.
- Opinion polls are done based on the opinions of the experts within or outside the firm.

- To control the subjective nature of the personal insights, the average forecast of the group is
used as the forecast.
- There are different polling techniques such as
✓ Executive Polling
✓ Sales Force Polling
✓ Consumer Intentions Polling.

Executive Polling
- Forecasting based on the polls of the experts in the field
- The top management of the firm or outside experts can be employed.
- The people in the top management are experts with very good experience of the firm.
- Outside experts have knowledge about the market and have free thinking.

E.g.: If a firm needs to make an investment decision about the share market, buying shares or some
alternative decisions. So, experts want to decide which one is better. So, we use this technique.

• To avoid a bandwagon effect (where the opinions of some experts might be overshadowed by
some dominant personality in their midst), the Delphi method can be used.
Bandwagon effect – If you want to forecast something and there are many experts in the panel. Some of
them are giants of the market. So, others may tend to trust their opinion whether it is true or false.
E.g.: Increase by 10% is Giant’s opinion, but my opinion is 20%. But I also used to follow giants’ opinion

Delphi method: Experts are polled separately, and then feedback is provided without identifying the
expert responsible for a particular opinion. Getting feedback confidentially.
Through this feedback procedure, the experts can arrive at some consensuses forecast.

Sales Force Polling

- The forecast is based on the opinions of the sales force in the field.
- Used to forecast in each region and for each product line
- Advantages:
✓ The sales force is the closest group to the market.
✓ They directly get the responses from the market.
✓ They can make a better prediction about the firm’s demand, competing brands in the
market and identify ongoing changes.

Consumer Intensions Polling

- Forecasts based on the responses of potential buyers
- Companies selling automobiles, furniture, household appliances, and other durable goods
sometimes poll a sample of potential buyers on their purchasing intentions.

Soliciting Foreign Perspective

- Mostly related to Exports

- Many firms sell an increasing share of their output abroad and face competition at home and
abroad from foreign countries.
- Therefore, they should forecast changes in foreign markets.
- To get an international perspective, firms can form councils of distinguished foreign dignitaries
and business people.

Advantages:
✓ A firm’s management usually concentrates on immediate concerns and is unable to evaluate
global situations.
✓ There is no better way to forecast international markets.
✓ Councils can fully pay attention to international markets without engaging in the operational
activities of the firm.
 Quantitative Techniques for Forecasting

- Quantitative forecasting methods use statistical techniques to forecast demand

- Getting quantitative data and analysis them using statistical techniques.

- Main quantitative methods:

✓ Time-Series Analysis
✓ Smoothing Techniques
✓ Barometric Methods
✓ Econometric Models
✓ Input-Output Forecasting

1. Time-Series Analysis
- Use historical data to analysis future.
- Forecast based on the analysis of time-series data
- Time-series data: values of a variable arranged chronologically (In order)

- Plot past data examine the trend forecast the future

- Assumption: Past trends will continue in the future.

- When changes in a variable show a clear pattern over time, this is appropriate. If no pattern in
past data time series can’t be used.

Reasons for the Fluctuations in Time-series Data

• Secular trend
- Long-run increases or decreases in data.
- A secular trend or market is one that is likely to continue moving in the same general direction
for the foreseeable future.
- Non-periodic variation
- To show trend
E.g.: Declining trend of demand for typewriters

• Cyclical fluctuations
- Major expansions and contractions (Decline) in data that recur every several years
- Draw a smoot line and see fluctuations.
- An economic cycle is the overall state of the economy as it goes through four stages in a cyclical
pattern: expansion, peak, contraction, and trough
E.g.:
Cyclical changes in construction industry – In areas with harsh winters, construction slows down
during the winter months and picks up during the summer.
Businesses that supply these industries have to plan for these seasonal fluctuations and build up
enough cash reserves to get them through the slow seasonal periods.
 • Seasonal variations
- Regular fluctuations recur during each year because of weather and social customs.
- They are variations of a periodic nature that recur regularly.
- In an economic context, seasonal variations can be caused by the following events like Climatic
conditions, Customs appropriate for a population
E.g.: Increased demand for textile during new year festival

The Difference Between Seasonal Economic Fluctuations & Cyclical Economic Fluctuations
- Seasonal economic fluctuations refer to short-term movements in economic indicators that
generally follow a consistent pattern each year, according to the U.S. Federal Reserve Bank of
Chicago. For example, an example of a difference between cyclical and seasonal variation would
be when farm and fishing income may rise during the summer months when there is activity in
those sectors.
- Cyclical fluctuations are alternating periods of contraction and expansion that can last 18 months
or longer from the peak to the trough of the cycle. Consumer and business demand falls during
contraction and rises during expansion, explains Inc. magazine. Businesses respond to
contractions or recessions by cutting back on staff, reducing operating expenses and delaying
capital investment decisions.

• Irregular or random influences

- Variations in data due to wars, natural disasters, strikes, etc.
- No specific pattern.
- Happened because of shocks. (Unexpected Variances)
- The impact of these fluctuations is usually limited to a certain industry or market.
For example, a flood may affect the distribution capability within a specific region
In time series,
- First get secured trend and make forecast.
- Consider cyclical fluctuations and improve the forecast.
- Seasonal fluctuations and forecast them.
- Improve again considering irregular ones.
- This is a continuous process. Not a separate thing.

Trend Projection
- Look at the graph and identify the trend.
- Simplest form of time-series analysis
- Assumes there is an identifiable trend in data

- Projects the past trend by fitting a line and extending it to future.

- Method: Regression analysis to derive a trend line
- Considers secular trend factor only

01. Linear Tend Line based on Constant Absolute Amount of Growth

St = S0 + b.t
t = Time period
St = Sales in the period ‘t’
S0 = Sales in the base period (t = 0) (Intercept)
b = Absolute amount of sales growth per period (Slope of the equation)

- To get the relationship between time and sales.

Example: Sales of electricity (millions of kilowatt-hours)

Multiple R 0. 303 8
R Square 0. 334 2
Adjusted R
Square 0. 0012
Standard Error 1.81 3 9
Observations 1

ANOVA

Regression 1 2.811 2.811 1 .00 4 0.001314

Residual 14 4 .18824 3.2991
Total 1 99

Intercept 11. 0.9 2 0 12.4933 . E- 9.8 0 13.94292

t . 11 0.098 0 4.0009 . 1 1 0.182844 0. 0 392
Linear Trend:
St = 11. + . t
S0 = 11.9 = Sales in the base period (4th quarter of 2012) is 11.9 million kilowatt-hours
b = Electricity sales increase at an average rate of 0.394 million kilowatt-hours per quarter

Forecasts based on the estimated trend line

S1 = 11.9 + 0.394(1 ) = 18. in 1st quarter of 201
S18 = 11.9 + 0.394(18) = 18.99 in 2nd quarter of 201

Constant Absolute Amount of Growth (b) = 1 . – 1 .6 = .

Sf (Yellow Color) is
the trend Line

02. Trend Line based on Constant Percentage Growth

Equation is non – linear and we must convert in to linear using natural logarithms.

St = S (1 + g)t
t = Time period
St = Sales in the period ‘t’
S0 = Sales in the base period (t = 0)
g = Constant percentage growth rate

ln St = ln S + t ln (1 + g)
Sales of electricity (millions of kilowatt-hours)
Multiple R 0. 3 421
R Square 0. 40844
Adjusted R
Square 0. 0804
Standard Error 0.119 42
Observations 1

ANOVA

Regression 1 0.23 44 0.23 44 1 .490 0.0011 8

Residual 14 0.200 33 0.014338
Total 1 0.43 1 8

Intercept 2. 6 1 0.0 2 93 39. 0489 . 2E-16 2.3 223 2. 21 92

t . 26 1 0.00 494 4.0 08 4 . 116 0.012443 0.040299

Linear Trend:
ln St = 2. + . 26 t
ln S0 = 2.49
S0 = antilog of 2.49 = 12.0 = Sales in the base period (4th quarter of 2012) is 12.0 million kilowatt
hours
ln (1+g) = b 0.02
1+g = antilog of 0.02 = 1.02 = Estimated growth rate of electricity sales is 2. % per quarter

Estimated trend line: St = 12. 6 (1. 26)t

Forecasts based on the estimated trend line

S1 = 12.0 (1.02 )1 = 18. in 1st quarter of 201
S18 = 12.0 (1.02 )18 = 19.14 in 2nd quarter of 201
Seasonal Variations
- Improve the forecast by incorporating the seasonal variations
- Methods:
✓ Ratio-to-Trend method
✓ Dummy Variable method

1. Ratio-to-Trend method

Example: Calculation of Seasonally Adjusted Forecast for Quarter 1 of 201

Trend Forecast for the 1st quarter of 201 = 11.9 + (0.394 X 1 ) = 18. 0
Seasonally Adjusted Forecast for the 1st quarter of 201 = (18. 0) (0.88 9) = 1 . 0

2. Dummy Variable Method

- How many dummy variables are required? As we have 4 quarters, we need 3 dummies (4-1)
- Use dummy variables to nominal scale variables.
- First define dummy variables.

D1: 1 = 1st quarters, 0 = Otherwise

D2: 1 = 2nd quarters, 0 = Otherwise
D3: 1 = 3rd quarters, 0 = Otherwise
Q4 can be considered as base category, which we didn’t establish a dummy variable.

Multiple R 0.99493 St = a + b1t + b2D1t + b D2t + b D t

R Square 0.989899
Adjusted R Square 0.98 22
Standard Error 0.301 11
Observations 1

ANOVA

Regression 4 98 24. 2 9. .81E-11

Residual 11 1 0.090909
Total 1 99

Intercept 12. 0.22 134 .382 2 6. E-1 12.2 228 13.24 2

t . 0.01 8 22.248 1. E-1 0.33 902 0.412098
D1 -2. 0.21911 -10.8391 .2 E- -2.8 2 -1.892 3
D2 1. 0.21 849 8.10 09 . E- 6 1.2 4919 2.22 081
D3 -2.12 0.2138 -9.93 13 . E- -2. 9 2 -1. 428
 St = a0 + b1t + b2D1t + b3D2t + b4D3t
St = 12. – . t – 2. D1t + 1. D2t – 2.12 D t

S1 = 12. – (0.3 *1 ) – (2.3 *1) + (1. *0) – (2.12 *0)

S18 = 12. – (0.3 *18) – (2.3 *0) + (1. *1) – (2.12 *0)
S19 = 12. – (0.3 *19) – (2.3 *0) + (1. *0) – (2.12 *1)
S20 = 12. – (0.3 *20) – (2.3 *0) + (1. *0) – (2.12 *0)

Drawbacks of Time-Series Analysis

• Forecasts are based on the assumption that the same pattern in secular trends and seasonal
variations will remain in future also, but the patterns may change.
• It is difficult or impossible to consider cyclical fluctuations and irregular influences with time-
series analysis.

2. Smoothing Techniques

- These predict value of a time-series on the basis of some average of its past values. (Based on
average of its past values forecast future values)
- Smoothing techniques are useful when the time-series exhibit little trend or seasonal
variations, but a great deal of irregular or random variation.
- The irregular or random variation in data is smoothed using these techniques and then, future
values are forecasted based on some average of past observations.
- Smoothing Techniques:
✓ Moving Averages
✓ Exponential Smoothing

Moving Averages
- Forecasted value is the average of data from w periods prior to the forecasted period.

E.g.: Three period moving average (w = 3)

We forecast the value in the next period by taking the average of the previous three periods.

- The greater the number of periods used, the greater the smoothing effect because each new
observation receives less weight.
- Most immediate past observations receive less weight.

E.g.: W=2 0.
W=4 0.2
W= 0.2
 Which moving average forecast
is better?
Calculate Root-Mean-Square
Error (RMSE) to find it.

t = Time period
At = Actual value
Ft = Forecasted value
n = Number of differences

Lower is the better

Three-quarter Moving Average Forecast is marginally better than Five-quarter Moving Average Forecast.
Therefore, we have little more confidence over 21.33 than 20. .

Exponential Smoothing
- Use both actual and forecast values for forecasting
- Simple moving averages place equal weights on all data points, even though more recent
observations are more important.
- If recent observations are more accurate and influential than past, accuracy may be at stake
- Exponential smoothing technique avoids that problem.
 - Under exponential smoothing, the forecast for the period t+1 (Ft+1) is a weighted average of the
actual and forecasted values at period t.
- The actual value at period t is assigned a weight (w) between 0 and 1, and the forecasted value
at period t is assigned a weight of 1-w.
- The greater is the value of w, the greater is the weight given to the value of the period t as
opposed to previous periods.

The forecasted value of the period t+1 is,

t = Period under consideration

t+1 = Next period
At = Actual value
w = weight
Ft = Forecasted value at period t

N : 1=A h b

Which weight is better?

Calculate Root-Mean-Square Error

(RMSE) to find it.

t = Time period
At = Actual value
Ft = Forecasted value
n = Number of differences
The forecast based on w=0.3 is better than the forecast based on w=0. .
Therefore, we have more confidence over 21.0 than 21.42.

Both exponential smoothing forecasts are better than moving average forecasts. Why?
 . Barometric Forecasting

- Focused on cyclical fluctuations.

- One way to predict turning points in business cycles is to use the indices of leading economic
indicators. They precede changes in the level of general economic activity.
- Like barometer forecasts changes in weather based on the changes in the mercury level, leading
indicators forecast changes in economic conditions.
- A rise in the leading economic indicators forecasts an increase in general economic activity, and
vice versa.

Three main indicators:

1. Leading Indicator: Observe
before changes happen in
industry.
2. Coincident Indicator: Occur
same time when cyclical
change occurs.
. Lagging Indicator: Observe
after the industry cycle
change

Drawback of Barometric Forecasting

Barometric forecasting gives little or no indication of the magnitude of the forecasted change in the level
of economic activity. It only provides a qualitative forecast about the turning points.

. Econometric Models
- Identify the relationship between dependent variables and independent variables.
- They seek to identify and measure the relative importance (elasticity) of various determinants of
demand.
- Econometric forecasts allow managers to determine the optimal policies for the firm as they
explain and quantify the relationship between a determinant of demand and quantity
demanded.
- Two types: Single-Equation Models and Multiple-Equation Models
 E.g.: Estimated demand function for air travel between New York and London (from 19 to 19 8)
ln Qt = 2. – 1.2 ln Pt + 1. ln GNPt (R2 = . )

Qt = No. of passengers per year (‘000)

Pt = Average yearly airfare adjusted for inflation (US $)
GNPt = US Gross National Product adjusted for inflation (US $ billion)

h h m y h 1 7 b $ 0 GN
b $ 1480. m 1 7 ?

. Input-Output Forecasting
- The input-output table examines the interdependence among various industries and sectors of
the economy.
- It shows the use of the output of each industry as inputs by other industries and for final
consumption.
E.g.: How an increase in demand for Auto mobile will lead to an increase in demand
for steel, glass, tires, plastic, upholstery materials, etc.

- Input-output analysis allows us to trace all these inter-industry input and output flows and to
determine the total increase of all inputs required to meet the increased demand for trucks.
- This method is time consuming and costly.