Demand Forecasting

Demand Forecasting
• Demand Forecasting refers to an estimate of future demand for the
product. It is an “objective assessment of the future course of
demand”. It is essential to distinguish between forecast of demand
and forecast of sales. Sales forecast is important for estimating
revenue, cash requirements and expenses. Demand forecast relate to
production inventory control, timing, reliability of forecast etc.
• Accurate demand forecasting is essential for a firm to enable it to
produce the required quantities at the right time and to arrange well
in advance for the various factors of production. Forecasting helps the
firm to assess the probable demand for its products and plan its
production accordingly.
Objectives
• Short-term Objectives
• a. Formulating production policy:
• Helps in covering the gap between the demand and supply of the product.
The demand forecasting helps in estimating the requirement of raw material
in future, so that the regular supply of raw material can be maintained. It
further helps in maximum utilization of resources as operations are planned
according to forecasts. Similarly, human resource requirements are easily met
with the help of demand forecasting.
• b. Formulating price policy:
• Refers to one of the most important objectives of demand forecasting. An
organization sets prices of its products according to their demand. For
example, if an economy enters into depression or recession phase, the
demand for products falls. In such a case, the organization sets low prices of
its products.
 • c. Controlling sales:
• Helps in setting sales targets, which act as a basis for evaluating sales performance.
An organization make demand forecasts for different regions and fix sales targets for
each region accordingly.
• d. Arranging finance:
• Implies that the financial requirements of the enterprise are estimated with the help
of demand forecasting. This helps in ensuring proper liquidity within the
organization.
• Long-term Objectives
• a. Deciding the production capacity:
• Implies that with the help of demand forecasting, an organization can determine the
size of the plant required for production. The size of the plant should conform to the
sales requirement of the organization.
• b. Planning long-term activities:
• Implies that demand forecasting helps in planning for long term. For example, if the
forecasted demand for the organization’s products is high, then it may plan to invest
in various expansion and development projects in the long term.
Steps in Demand Estimation
Setting objective of demand forecasting
• Deciding the time period of forecasting whether an organization
should opt for short-term forecasting or long-term forecasting

• Deciding whether to forecast the overall demand for a product in the

market or only- for the organizations own products

• Deciding whether to forecast the demand for the whole market or for
the segment of the market

• Deciding whether to forecast the market share of the organization

Determining Time Period
• Involves deciding the time perspective for demand forecasting.
Demand can be forecasted for a long period or short period.
• In the short run, determinants of demand may not change
significantly or may remain constant, whereas in the long run, there is
a significant change in the determinants of demand.
Selecting a Method for Demand Forecasting
• The method of demand forecasting differs from organization to
organization depending on the purpose of forecasting, time frame,
and data requirement and its availability.
• Selecting the suitable method is necessary for saving time and cost
and ensuring the reliability of the data.
Collecting Data
• Requires gathering primary or secondary data.
• Primary’ data refers to the data that is collected by researchers
through observation, interviews, and questionnaires for a particular
research.
• Secondary data refers to the data that is collected in the past; but can
be utilized in the present scenario/research work.
Estimating Results
• Involves making an estimate of the forecasted demand for
predetermined years.
• The results should be easily interpreted and presented in a usable
form.
• The results should be easy to understand by the readers or
management of the organization.
Methods of Demand Forecasting
Methods of
Demand
Forecasting

Survey Statistical
Method Method

Expert Market Trend Other

Delphi Barometric Econometric
Opinion Experiment Projection Statistical
Method Method Method
Method Method Method Method
Survey Method
• Survey method is one of the most common and direct methods of
forecasting demand in the short term.
• This method encompasses the future purchase plans of consumers
and their intentions.
• In this method, an organization conducts surveys with consumers to
determine the demand for their existing products and services and
anticipate the future demand accordingly.
1. Opinion Survey method:
This method is also known as Sales- Force –Composite method or collective
opinion method. Under this method, the company asks its salesmen to submit
estimate for future sales in their respective territories. This method is more
useful and appropriate because the salesmen are more knowledgeable about
their territory.

2. Expert Opinion:
Apart from salesmen and consumers, distributors or outside experts may also
be used for forecast. Firms in advanced countries like USA, UK etc...make use of
outside experts for estimating future demand. Various public and private
agencies sell periodic forecast of short or long term business conditions.
3. Delphi Method:
It is a sophisticated statistical method to arrive at a consensus. Under this
method, a panel is selected to give suggestions to solve the problems in hand.
Both internal (Ex. Executives) and external experts (Ex. Investment Analysts,
academicians, consultants etc.) can be the members of the panel. Panel
members are kept apart from each other and express their views in an
anonymous manner.
Market Experiments and Studies
Test marketing
• A test area is selected, which should be a representative of the whole
market in which the new product is to be launched.
• A test area may include several cities having similar features i.e.
population, income levels, cultural and social background, choice and
preferences of consumers.
• Market experiments are carried out by changing prices, advertisement
expenditure and other controllable variables influencing demand.
• After such changes are introduced in the market, consequent changes in
demand over a period of time are recorded.
Experiments in laboratory or consumer clinic method
• Under this method consumers are given some money to buy in a
stipulated store goods with varying prices, packages, displays etc.
• They are also requested to fill a questionnaire asking reasons for the
choices they have made.
• The experiment reveals the consumers responsiveness to the changes
made in prices, packages and displays.
End-use Method
• Under this method, the sales of a product are projected through a
survey of its end-users.
• A product is used for final consumption or as an intermediate product
in the production of other goods in the domestic market, or it may be
exported as well as imported.
• The End Use Method is particularly suitable for Industrial Products
such as raw materials or intermediary products because unlike
consumer goods these are limited in number and can be surveyed
exhaustively.
Statistical Methods
• It is used for long term forecasting.
• In this method, statistical and mathematical techniques are used to
forecast demand.
• This method is relies on past data.
• This method includes:
1. Trent projection method: Under this 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). Here we try to ascertain the trend in the time series.
Trend in the time series can be estimated by using least square method or
free hand method or moving average method or semi-average method.
• The trend projection method undertakes two more methods in
account, which are as follows:
• Graphical Method: Helps in forecasting the future sales of an organization
with the help of a graph. The sales data is plotted on a graph and a line is
drawn on plotted points.
• Fitting Trend Method: Implies a least square method in which a trend line
(curve) is fitted to the time-series data of sales with the help of statistical
techniques. In this, for fitting a line to a set of observed data points in such a
manner that the sum of the squared deviations between the calculated and
observed values are minimised. This is why it is called as ‘Least square
method’.
• In a linear trend, the equation used is y=a+bx where
• Y represents sales.
• a & b are the values to be estimated from the past data of sales.
• x is the year for which the sales is being forecast.
• To solve the above equation y= a+bx, we make use of the following normal
equation:
Σy = na + b Σx
Σxy = aΣx + b Σx2
 Estimation of Trend by the Method of Least Squares
Q. The annual sales of a company are as follows:
Year 1991 1992 1993 1994 1995
Sales ‘000 45 56 58 46 75
Using the method of least squares, fit a st. line trend and estimate the annual
sales of 1997.

Year Sales 1990 = 0 x2 xy Estimated

Time- Trend’000
Deviation Y=45 + 5x
y
x
1991 45 1 1 45 50
1992 56 2 4 112 55
1993 78 3 9 234 60
1994 46 4 16 184 65

1995 75 5 25 375 70

n=5  y = 300  x = 15  x2 = 55  xy = 950

 n=5  y = 300  x = 15  x2 = 55  xy = 950

 y = n.a. + b  x …1 St. line equation is Y = a + bx

xy = a x + b x2 …. 2
Substituting the values of a and b,
Substituting the computed values Y = 45 + 5x
we have, Therefore,
300 = 5a + 15b ….3 (x 3) Y1991 (x=1) = 45 + 5(1) = 50
950 = 15a + 55b …. 4
Multiplying (3) by 3 we have Y1992 (x=2) = 45 + 5(2) = 55
900 = 15a + 45b Y1993 (x=3) = 45 + 5(3) = 60
950 = 15a + 55b Y1994 (x=4) = 45 + 5(4) = 65
Therefore, 10b = 50, b=5 Y1995 (x=5) = 45 + 5(5) = 70
Substituting b = 5 in (3) Y1996 (x=6) = 45 + 5(6) = 75
300 = 5a + 15(5)
300 = 5a + 75 Forecast for the year 1997
5a = 225 a = 45 Y1997 (x=7) = 45 + 5(7) = 80
i.e. Rs.80,000/-
2. Regression : Refer to the most popular method of demand forecasting. In regression
method, the demand function for a product is estimated where demand is dependent
variable and variables that determine the demand are independent variable.
If only one variable affects the demand, then it is called single variable demand function.
Thus, simple regression techniques are used. If demand is affected by many variables,
then it is called multi-variable demand function. Therefore, in such a case, multiple
regression is used.
 Illustration: Suppose a company manufacturing tractors finds that a
relationship exists between sale of tractors and Farm Income Index
published by CSO. Table below shows the number of tractors sold and
the corresponding farm income index 1988 through 1992. Regression
equation is calculated as follows:

Year Farm Sales of X1 Y1 x1y1 x12

Income Tractors
Index (x) (y)
1988 100 110 10 11 110 100

1989 110 130 11 13 143 121

1990 140 150 14 15 210 196

1991 150 160 15 16 240 225

1992 200 180 20 18 360 400

n=5 X1=70 Y1 =73 X1y1=1063 X12=1042
The equations to be solved simultaneously are:
y1 = n.a. + b  x1 …….(1)
x1y1 = a x1 + b x12……(2)

Substituting the various values, we get,

73 = 5a + 70b (x14)…(3) y1 = 5.36 + 0.66x1

1063 =70a + 1042b Y = 10(5.36) + 0.66(x/10)10
1022 =70a + 980b = 53.6 + 0.66x
62b = 41 b = 41/62 = 0.66 If the index of farm income becomes
210, sale of tractors will be
Substituting the value of b in (3) Y = 53.6 + 0.66(210)
73 = 5a + 70 (0.66) = 5a + 46.2 = 53.6 + 138.6
5a = 73 – 46.2 = 26.8 = 192 tractors.
a = 26.8/5 = 5.36
a = 5.36 b = 0.66
Barometric Method
• A barometer is an instrument of measuring change. This method is based
on the notion that “the future can be predicted from certain happenings in
the present.” In other words, barometric techniques are based on the idea
that certain events of the present can be used to predict the directions of
change in the future. This is accomplished by the use of economic and
statistical indicators which serve as barometers of economic change.
• Generally forecasters correlate a firm’s sales with three series: Leading
Series, Coincident or Concurrent Series and Lagging Series:
• (a) The Leading Series: The leading series comprise those factors which
move up or down before the recession or recovery starts. They tend to
reflect future market changes.
• For example, baby powder sales can be forecasted by examining the birth
rate pattern five years earlier, because there is a correlation between the
baby powder sales and children of five years of age and since baby powder
sales today are correlated with birth rate five years earlier, it is called
lagged correlation. Thus we can say that births lead to baby soaps sales.
• (b) Coincident or Concurrent Series: The coincident or concurrent series are
those which move up or down simultaneously with the level of the
economy. They are used in confirming or refuting the validity of the leading
indicator used a few months afterwards. Common examples of coinciding
indicators are G.N.P itself, industrial production, trading and the retail
sector.
• (c) The Lagging Series: The lagging series are those which take place after
some time lag with respect to the business cycle. Examples of lagging
series are, labour cost per unit of the manufacturing output, loans
outstanding, leading rate of short term loans, etc.
Econometric Method
• The Econometric Methods make use of statistical tools and economic
theories in combination to estimate the economic variables and to forecast
the intended variables.
• The econometric model can either be a single-equation regression model
or may consist a system of simultaneous equations. In most commodities,
the single-equation regression model serves the purpose.
• But, however, in the case where the explanatory economic variables are so
interdependent or interrelated to each other that unless one is defined the
other variable cannot be determined, a single-equation regression model
does not serve the purpose. And, therefore in such situation, the system of
simultaneous equations is used to forecast the variable.