CHAPTER FOUR

MARKET AND DEMAND

ANALYISIS
Chapter Content
4.1. Situational Analysis and Specification of Objectives
4.2. Collection of Secondary Information
4.3. Conduct Market Survey
4.4. Characterization of Market Survey
4.5. Demand Forecasting
4.6. Market Planning
4.1. Market and Demand Analysis

 In most circumstances, the first step in project analysis is to

 estimate the potential size of the market for the product
proposed to be manufactured (or service planned to be
offered) and
 get an idea about the market share that is likely to be
captured.
 Hence, market and demand analysis is concerned with two
broad issues:
i. what is the likely aggregate demand for the product
/service?
ii. What share of the market will the proposed project enjoy?
Situational Analysis and Specification of Objectives

 Situational analysis is a way of generating data about the

market and demand informally by talking to customers,
competitors, middlemen, and others in the industry.
 If such analysis generates enough data, a formal study need
not be carried out, particularly when cost and time
considerations so suggest.
 In most cases, of course, a formal study of the market and
demand is warranted.
 To conduct such a study, it is necessary to spell out
objectives clearly and comprehensively.
 A helpful approach to spell out objectives is to structure
them in the form of questions.
Collection of Secondary Information

 In order to answer the questions listed while describing the

objectives of the study, information may be obtained from
secondary and / or primary sources.
 Secondary information is information that has been
gathered in some other context and is already available.
 Secondary Information for market and demand analysis
may be obtained from central statistics office, economic
survey, national sample survey reports, academic studies,
etc.
 Information gathered from these secondary sources should
be carefully examined in terms of their reliability, relevance,
and accuracy for intended purpose
Conducting Market Survey
 A comprehensive basis for market and demand analysis may be
difficult to obtain from secondary information.
 As such, primary information through a market survey tailored
to the specific needs of the project under preparation is
necessary.
 There are two types of survey for this purpose. These are a
census survey and a sample survey.
 In a census survey, the whole population is covered. Census
surveys are employed principally for investment goods and
intermediate goods when such goods are used by small number
of firms. These types of surveys often tend to be costly and
infeasible.
 Due to the above limitations, the market survey in practice is a
sample survey, for which a sample of population is drawn.
The information sought in a market survey in the context of the
proposed project may relate to one or more of the following:
 Total demand and rate of growth of demand
 Demand in different segments of the market
 Income and price elasticity of demand
 Motives for buying
 Unsatisfied needs
 Purchasing plans and intentions
 Satisfaction with existing products
 Distributive trade practices
 Attitude towards the product or service
 Socio economic characteristics of buyers
Characterization of Market Survey

Based on the information gathered from a sample survey

or secondary sources, the market for the product or service
may be described in terms of the following ways:
 Effective demand in the past and present,
 Break down of demand
 Price
 Consumers
 Methods of distribution and sales promotion,
 Supply and competition
 Government policy
Effective demand in the past and present
 To get the past and present effective demand, the starting
point typically is apparent consumption which is defined as:
Production + imports - exports - changes in stock level
 In competitive market effective demand and apparent
consumption are equal.
 However, In most developing countries, where competitive
markets do not exist for a variety of products due to
exchange restrictions and controls on production and
distribution, the figure of apparent consumption may have
to be adjusted for market imperfections.
Break down of demand
 To get a deeper insight to the nature of demand, the
aggregate (total) market demand may be broken down into
demand for different segments of the market.
 Market segments may be defined by (i) Nature of product,
(ii) Consumer group, and (iii) Geographical division.
 Segmental information is helpful because ……….?
Price
 Price statistics must be gathered with statistics pertaining
to physical quantities. It may be helpful to distinguish the
following types of prices:
(i) Manufacturer’s price quoted as FOB (free on board) price
or CIF (cost, insurance, and freight) price, (ii) Landed price for
imported goods, (iii)Average whole sale price, and (IV)
Average retail price.
Consumers
 Consumers may be characterized along two dimensions as
follows:
Demographic and Attitudinal
sociological
Age Preferences
Sex Intentions
Income Habits
Profession Attitudes
Residence Responses
Social background
Methods of distribution and sales promotion
 The methods of distribution may vary with the nature of the
product.
 Capital goods, industrial raw materials and consumer
products tend to have differing distribution channels.
 Likewise, methods used for sales promotion (advertizing,
discounts, gift schemes, etc) may also vary from product to
product.
Supply and competition
 It is necessary to know the existing sources of supply and
whether they are foreign or domestic.
 Competition from substitutes and near – substitutes should
be specified.
Government policy
 Government policy may influence the market and the
demand for a product/service.
 Governmental plans, policies, and legislations, which have
an influence on the market and demand of the product
under examination should be disclosed.
 These are reflected in: production targets in national plans,
import and export trade controls, import duties, export
incentives, excise duties, sales tax, industrial licensing, etc
Demand Forecasting
 Once the information gathered about various aspects of the
market and demand from primary and secondary sources, an
attempt may be made to estimate future demand.
 There are several demand forecasting methods.
 These methods may be classified in three broad categories as
shown below:
I. Qualitative Methods; These methods depend essentially on
the judgment of experts to translate qualitative information in to
quantitative estimates. The important qualitative methods are:
- Jury of executive method
- Delphi method
II. Time Series Projection Methods; These methods generate
forecasts on the basis of an analysis of the historical time series. The
important series projection methods are:
- Trend projection method
- Exponential Smoothing method
- Moving average method
III. Casual Methods; These method is more analytical than the
preceding methods, casual methods seek to develop forecasts on
the basis of cause – effect relationships specified in an explicit,
quantitative manner. The important casual methods are:
- Chain ratio method
- Consumption level method
- End use method
- Leading indictor method
I. Qualitative Method
Jury of Executive Option Method
 This method, which is popular in practice, involves soliciting
the opinions of a group of managers on expected future sales
and combining into sales estimate.
 The advantages of this method are: (i) It is an expeditious
method. (ii) It permits a variety of factors like economic
climate, competitive environment, consumer preferences,
technological developments, and so on to be included in the
subjective estimates. (iii) It has immense appeal to
managers.
 The disadvantages of this method are: (i) The biases
underlying subjective estimates can not be easily avoided. (ii)
The reliability of this technique is questionable.
Delphi Method
 This method is used for eliciting the opinions of group of
experts with help of a mail survey. The steps involved in this
method are;
 a questionnaire is sent to a group of experts by mail and asked
to express their views.
 The responses received are summarized without disclosing the
identity of the experts, and sent back to experts, along with a
questionnaire meant to probe further the reasons for extreme
views expressed in the first found.
 The process may be continued for one or more rounds till a
reasonable agreement emerges in the views of experts.
 Delphi method appeal to many organizations for the
following reasons: (i) It is intelligible to users. (ii) It seems to
be more accurate and less expensive than the traditional face
– to – face group meetings.
II. Time series projection method
Trend Projection
 This method involves (a) determining the trend of consumption by
analyzing past consumption statistics and (b) projecting future
consumption by extrapolating the past trend.
 For trend projection, the most commonly employed relationship is
the linear relationship.
Yt = α + bt
 Where Yt is the demand for year t, t is the time variable, α is the
intercept of the relationship, and b is the slope of the relationship.
Example
 Sailboat Sales company is a major marine dealer in Chicago. The
firm has experienced tremendous sales growth in the past several
years. The Management likes to forecast the demand in order to
enable them to control inventories.
 The annual sales, in number of boats, for one particular sailboat
model for the past five years are:
Year (T) 1 2 3 4 5
Sales (Y) 11 14 20 26 34
 Forecast demand for period 6 using trend projection method.
T Y TY T2
111 11 1
2 14 28 4
3 20 60 9
4 26 104 16
5 34 170 25
Total 15 105 373 55
b= 373 – 5 (3) (21) = 5.8
55 – 5 (9)
α = 21 – 5.8 (3) = 3.6
Y6 = 3.6 + 5.8 (6) = 38.4
Exercise
Year (T) 1 2 3 4
Sales (Y) 100 120 130 145
 Forecast demand for period 5 using trend projection
method.
Exponential smoothing Method
 In exponential smoothing, forecasts are modified in the
light of observed errors. If the forecast value for year t, Ft,
is less than the actual value for year t, St, the forecast for
the year t + 1, Ft + 1, is set higher than Ft. If Ft > St, Ft + 1 is
set lower than Ft.
 In general,
Ft + 1 = Ft + α et
 Where: Ft + 1 = Forecast for year t + 1
α = Smoothing Parameter (which lies between 0
and 1)
et = Error in the forecast for year t = St – Ft
Example
 Based on the data given below, forecast demand for period
2 and 3 using exponential smoothing method.

 F1 = 29, S1 = 28, S2 = 30, and α = 0.2

 F2 = 29 + 0.2(-1) = 28.8
 F3 = 28.8 + 0.2(1.2) = 29.04
 Note that F2 is less than F1, and F3 is higher than F2……
why?
Moving Average Method
 This method smoothes out fluctuations when the data set
show irregular variations.
 The forecast for the next period is equal to the average of
the sales for several preceding periods.
 Hence, the moving average is ‘centered’ against the mid –
point of the averaging period. In symbols,
 Ft+1 = St + St-1 + … + St-n+1
n
 Where, Ft+1 is the forecast for the next period, St is the sales
for the current period, and n is the period over which
averaging is done.
 Example: Xyz co. has provide us the following data. If n is
set to be 4, what would be the forecast for period 5 using
moving average method?
Year Sales
1 28
2 29
3 28.5
4 31
5 34.2
6 32.7
Casual methods
Chain Ratio Method
 Under this method, the potential sales of a product may be
estimated by applying a series of factors to a measure of
aggregate demand.
 The chain ratio method uses a simple analytical approach to
demand estimation.
 However, its reliability is critically dependent on the ratios
and rates of usage used in the process of determining the
sales potential.
 While some of these ratios and rates of usage may be based
on objective proportions, others will have to be subjectively
defined.
Example
 The U.S firm estimated the potential sales for a product,
heated coat, in the following manner:
 Population in the country (U) = 280 million
 Proportion of U that are age over 16 (A) = 75%
 Male population that are age over 16 (M) = 50%
 Proportion of M that have income over $65(I)= 50%
 Proportion of I that live in cold states (C) = 50%
 Number of C that ski regularly (S) = 26.25 million
 Average number of ski coats purchased per year (Y) = 5 coats
 Total ski coats purchased per year (S) (Y) = 131.25 million
 Proportion of heated coat market the firm could capture= 15%
 Potential sales of the firm = 19,687,500
Consumption Level Method
 This is useful for a product which is directly consumed, and this method
estimates consumption level on the basis of elasticity coefficients, the
most important ones being the income and price elasticity of demand.
Income elasticity of demand;
 Refers the extent to which demand changes in response to variations
in income. It is measured as follows:
EI = Q2 – Q 1 × I 1 + I 2
I2 – I 1 Q2 + Q1
 Where E1 = Income elasticity of demand, Q 1 = quantity demanded in the
base year , Q2 = quantity demanded in the following year, I 1 = income
level in the base year, and I2 = income level in the following year
e.g; By using the following data determine E I?
Q1 = 50, Q2 =55, I1 = 1,000, and I2 = 1,020……… EI =4.81
 Demand forecast can be determined based on the information of
income elasticity of demand along with projected income.
 To illustrate, suppose the present per capital annual demand for
paper is 1kg and the present per capita annual income is Br. 16,400.
The income elasticity of demand for paper is 4.81. The projected
per capital annual income four years hence is expected to be 15
percent higher than what it is now. The projected per capital
demand for paper four years hence will be:
Present per Per capital Income
capita 1 + change in  elasticity
Demand income level of demand
= (1) (1 + 0.15 x 4.81) = 1.7215 kg
 The aggregate demand projection for paper will simply be:
 Projected per capital demand x Projected Population
 Income elasticity's differ not only between products but
also, for a given product, between different income groups
and different regions.
Price Elasticity of Demand;
 Measures the responsiveness of demand to variations in
price. It is expressed as follows:
Ep = Q2 – Q 1 × P1 + P2
P 2 – P1 Q2 + Q1
 Where Ep = Price elasticity of demand, Q1 = quantity
demanded in the base year, Q2 = quantity demanded in the
following year, P1 = price per unit in the base year, and P2 =
Price per unit in the following year
Example: The following information is available about a certain
product:
P1 = Br 800, Q1 = 20,000, P2 = Br. 1,000, Q2 = 19,000. What is the
price elasticity of demand?
EP = 19,000 – 20,000  800 + 1,000 = - 0.23
1,000 – 800 19,000 + 20,000
End – Use Method
 The end – use method is particularly suitable for assessing the
demand for intermediate products. This method utilizes
consumption coefficients, and is therefore, also called the
consumption coefficient method, involves the following steps:
1. Identify the possible uses of the product.
2. Define the consumption coefficient of the product for various
uses.
3. Project the output levels for the consuming industries.
4. Derive the demand for the product.
 Illustrative Example: A certain industrial chemical, Indchem,
is used by four industries, Alpha, Beta, Gamma, and Kappa.
The consumption coefficients for these industries, the
projected output levels for these industries for the year X,
and the projected demand for Indchem are shown in
following table. Projected Demand for Indchem
Industries Consumption projected output Projected Demand
Coefficient (tones In year X for Indchem in year
per unit of X (in tonnes)
output)
Alpha 2.0 10,000 20,000
Beta 1.2 15,000 18,000
Gamma 0.8 20,000 16,000
Kappa 0.5 30,000 15,000
TOTAL 69,000
Leading Indicator Method
 Leading indicators are variables which change ahead of
other variables, the lagging variables. Thus, observed
changes in leading indicators may be used to predict the
changes in lagging variables.
 For instance, the change in the level of urbanization ( a
leading indicator) may be used to predict the change in the
demand for air conditioners ( a lagging variables).
 There are two basic steps which are involved in this
method: (i) identify the appropriate leading indicator (s). (ii)
establish the relationship between the leading indicator (s)
and the variable to the forecast.
Econometric Method
 An econometric model is all about a mathematical
representation of economic relationship(s) derived from
economic theory. The primary objective of econometric analysis
is to forecast the future behavior of the economic variables
incorporated in the model.
 Practically, two types of econometric models are employed; the
single equation model and the simultaneous equation model.
The single equation model assumes that one variable, the
dependent variable (also referred to as the explained variable)
is influenced by one or more independent variables ( also
referred to as the explanatory variables). An example of the
single equation model is given below:
Dt = a0 + a1Pt +a2Nt
Where Dt = demand for a certain product in year t, P t = Price for the
product in year t, and Nt = income in year t.
 Simultaneous equation model depicts economic relationships in
terms of two or more equations.
GNPt = Gt + It + Ct
It = a0 + a1 GNPt
Ct = b0 + b1GNP1
 Where GNpt = gross national product for year t, Gt = governmental
purchases for year t, It = gross investment for year t, and Ct =
consumption for year t.
 An econometric model involves the following four broad steps:
 Specification: the expression of an economic relationship.
 Estimation: the determination of the parameter values and other
statistics.
 Verification: accepting or rejecting the specification.
 Prediction: involves projecting the values of explained variable (s)
 The econometric method, as a mechanism for demand
forecasting offers certain advantages:
 The process of econometric analysis sharpen the
understanding of complex cause – effect relationships.
(i) The econometric model provides a basis for testing
assumptions and for judging how sensitive the results are to
changes in assumptions.
 Econometric method are not free from certain drawbacks,
among these:
 It is expensive and data demanding.
(ii) To forecast the behavior of the dependent variable, one
needs the projected values of the independent variable (s).
Uncertainties in demand forecasting
 Demand forecasts are subject to error and uncertainty
which arise from three principal sources:
 Data about past and present market
 Method of forecasting
 Environmental change
Data about past and present market
 The analysis of past and present market, which serves as
the springboard for the projection exercise, may be vitiated
by the following inadequacies of data:
 Few observation
 Influence of abnormal factors
 Lack of standardization
Method of forecasting
 Methods used for demand forecasting are characterized by the
following limitation:
 Inability to handle unquantifiable factors
 Unrealistic assumptions
 Excessive data requirement
Environmental change
 The environment in which a business functions is characterized by
numerous uncertainties. The important sources of uncertainty are
mentioned below:
 Technological change
 Shift in government policy
 Developments on the international landscape
 Discovery of new sources of raw material
Market Planning
 An appropriate marketing plan should be formulated to reach
the proposed product/service to a desired level of customers.
The prime purpose of the marketing plan is meeting the
customer needs better than their competitors.
 In planning the market the detailed information that has been
collected and analyzed should be targeted on the following:
 Customer
 Distribution
 Promotion
 Pricing
 Services
 Market segmentation
End of the chapter!