Demand

Forecasting
Engineering
Economics –
assignment

Veeresh B – 07IT64
 Demand Forecasting
Introduction:
Demand and supply are the key factors of economic activity all around the
world. Demand can be defined as desire to purchase a product backed by the
ability to do so. For any producer in this economic scenario, it is extremely
important to know his market so as to utilize the resources to produce products
efficiently and also to obtain right quantity of resources. This requirement of
preparation and its benefits have lead to techniques of predicting demand. This
study of predicting demand is called Demand Forecasting.

Demand forecasting is very important to firms. It may involve informal

methods such as educated guesses of more formal methods employing
scientific/mathematical methods of survey, statistical calculations, analysis of past
markets and performance, etc. It is also critical in pricing the product, market
entry decisions, publicity expenditure required for that product. Such decisions
can make or mar a company.

However demand forecasting should not be confused with sales

forecasting.

Once a demand is predicted the results have a life-span up to which one

can rely upon them. This way we have short term and long term demand
forecasting.

Necessity for demand forecasting:

Accurate demand forecasting is essential for a firm to enable it to produce
the required quantities at the right time and arrange well in advance for the
various factors of production, viz., raw materials, equipment, machine
accessories, labor, buildings, etc.
 In a developing economy like India, supple forecasting is more important.
The main reason is that the market is huge and largely open for competition by
other firms and other products.

Some of the uses of short-term demand forecasting:

• Appropriate production scheduling.

• Reducing costs of purchasing raw materials.
• Determining appropriate price policy
• Setting sales targets and establishing controls and incentives.
• Evolving a suitable advertising and promotional campaign.
• Forecasting short term financial requirements.

Some of the benefits of long term forecasting:

• Planning of a new unit or expansion of an existing unit.

• Planning long term financial requirements.

 • Planning man-power requirements.

Factors involved in demand forecasting:

These are the main factors which should be kept in mind while doing
demand forecasting:

• Appropriate variables which influence the consumer’s choices:

 Price
 related item prices offered by the retailer or its competitors
 advertisements effects
 Sales tactics employed
 Time factors involved in product.
• How far ahead in time is the forecast needed for?
• The level of details needed. This can be Macro level, industry level or firm
level.

The criterion for good demand forecasting will involve:

• Accuracy. The data and interpretations should be accurate for target period
and also take care of market fluctuations

• Simplicity.

• Economy.

• Availability.

• Timeliness.
Determinants of demand:
The demand for a product depends on nature of product. For a Non-
durable product the consumer will consider: Price, price of possible substitutes,
consumer surplus, purchasing power, Income status.

But for a durable good the concerns will be: going for repairing it or
replacing it, price and income conditions not only at that point but also the saving
policy which the consumer is hoping to follow.

Also the consumers are not always rational and cannot be predicted as
such. They are highly influenced by their immediate society and external media.
Consumers are assumed to be able to order what, where, and when they desire.
The firm’s lack of prior knowledge about how the customers will order is the heart
of the forecasting problem.
Data required for estimating the demand for goods are the growth
prospects of the industry. The consumption of goods per unit of installed
capacity. The rate at which the industry expects to sell off the goods.

Techniques of demand forecasting:

Demand forecasting can be qualitative (Macroeconomic methods) or
quantitative (Microeconomic methods).

Here we are concentrating on qualitative methods. Some of the qualitative

methods are: consumer survey method and opinion poll method.

The consumer survey method is mainly of following types: consumer

enumeration method, sampling survey method, end use method. While the
opinion poll method involves experts opinion method, Delphi method, market
experimentation method.
Opinion poll methods:
• Delphi Method: A panel of experts is identified where an expert could be a
decision maker, an ordinary employee, or an industry expert. Each of them
will be asked individually for their estimate of the demand. An iterative
process is conducted until the experts have reached a consensus.
• Market experimentation method: Firms select two or three cities(markets)
having similar socio-economic conditions. Then they carry out different
demand experiments on their product by changing price, advertisements, etc.

• Experts’ opinion method: The opinions of a small group of high-level

managers are pooled and together they estimate demand. The group uses
their managerial experience, and in some cases, combines the results of
statistical models.
Consumer survey methods:
• Consumer enumeration method: In this method, almost all the potential
users of the product are contacted and are asked about the future plan of
purchasing the product in question. The quantities indicated by the
consumers are added together to obtain the probable demand for the
 product.

• Sample survey method - Under this method only a few potential consumers
selected from relevant market through a sampling method are surveyed, on
the basis of the information obtained, the probable demand may be
estimated through the following formula.

• End User Method - The end user method of demand forecasting is used for
estimating demand for inputs. Making forecast by this method requires
building up a schedule of probable aggregate future demand for inputs by
consuming industries and various other sectors

Analysis of Delphi method:

The Delphi method is a systematic, interactive forecasting method which

relies on a panel of independent experts. The carefully selected experts answer
questionnaires in two or more rounds. After each round, a facilitator provides an
anonymous summary of the experts’ forecasts from the previous round as well as
the reasons they provided for their judgments. Thus, experts are encouraged to
revise their earlier answers in light of the replies of other members of their panel.
It is believed that during this process the range of the answers will decrease and
the group will converge towards the "correct" answer. Finally, the process is
stopped after a pre-defined stop criterion (e.g. number of rounds, achievement of
consensus, stability of results) and the mean or median scores of the final rounds
determine the results.

Delphi is based on the principle that forecasts from a structured group of

experts are more accurate than those from unstructured groups or individuals.
The technique can be adapted for use in face-to-face meetings, and is then called
mini-Delphi or Estimate-Talk-Estimate (ETE). Delphi has been widely used for
business forecasting and has certain advantages over another structured
forecasting approach, prediction markets.

The following key characteristics of the Delphi method:

 • Structuring of information flow: The initial contributions from the experts
are collected in the form of answers to questionnaires and their comments
to these answers. The panel director controls the interactions among the
participants by processing the information and filtering out irrelevant
content. This avoids the negative effects of face-to-face panel discussions
and solves the usual problems of group dynamics.
• Regular feedback: Participants comment on their own forecasts, the
responses of others and on the progress of the panel as a whole. At any
moment they can revise their earlier statements. While in regular group
meetings participants tend to stick to previously stated opinions and often
conform too much to group leader, the Delphi method prevents it.
• Anonymity of the participants: Usually all participants maintain anonymity.
Their identity is not revealed even after the completion of the final report.
This stops them from dominating others in the process using their authority
or personality, frees them to some extent from their personal biases,
minimizes the "bandwagon effect" or "halo effect", allows them to freely
express their opinions, encourages open critique and admitting errors by
revising earlier judgments.

Facilitator and his role: The person coordinating the Delphi method can be known
as a facilitator, and facilitates the responses of their panel of experts, who are
selected for a reason, usually that they hold knowledge on an opinion or view.
The facilitator sends out questionnaires, surveys etc. and if the panel of experts
accept, they follow instructions and present their views. Responses are collected
and analyzed, and then common and conflicting viewpoints are identified. If
consensus is not reached, the process continues through thesis and antithesis, to
gradually work towards synthesis, and building consensus.

LIMITATIONS:
• Time consuming – reaching a consensus takes a lot of time.
• Participants may drop out.

Analysis of survey methods:

• Complete Enumeration Survey: Complete Enumeration Survey covers all
 the consumers. It resembles the Census Data Collection which considers
the entire population. In this case all the consumers are covered and
information is obtained from all regarding the prospective demand for the
product under consideration. The method of Complete Enumeration has
the advantage of being absolutely unbiased as far as consumer opinions are
concerned. We can obtain complete information by contacting every
possible present, past or would be consumers of the product. No doubt it is
not very easy to carry out the survey on such a large scale. Even the
collected information will be difficult and too tedious to be analyzed. The
reliability on such consumers’ information may be questionable, if the
opinions are not authentic.

• Sample Survey: In case of the sample survey method, few consumers are
selected to represent the entire population of the consumers of the
commodity consumed. The total demand for the product in the market is
then projected on the basis of the opinion collected from the sample. The
most important advantage of this method is that it is less expensive and
less tedious compared to the method of complete enumeration. The
sample chosen should not be too small nor too large. This method if
applied carefully will yield reliable results especially in case of new brands
and new products.

• End –Use Method: A given product may have different end uses. For
example: milk may have different end uses such as milk powder,
chocolates, etc. Therefore the end users of milk are identified. A survey is
planned of the end users and the estimated demands from all segments of
end users are added. This method of demand forecasting is easy to manage
if the number of end-users is limited. In this method the investigator
expects the end- users to provide correct information well in advance of
their respective production schedules.

Although the Survey Method is the most direct method of estimating

demand in the short-run; Joel Dean criticized this method by saying “there
are formidable barriers to learning the buying intentions of the household
consumers.” He adds “consumers are often inconsistent. The inability to
 foresee what choice the consumers will make when faced with multiple
alternatives in the market, restrict the usefulness of this method of
forecasting.”

Limitations:

• Availability heuristic Involves using vivid or accessible events as a

basis for the judgment.
• Law of small numbers. People expect information obtained from a
small sample to be typical of the larger population.
• Although the opinion surveys are simple and straightforward, there
is an element of subjectivity involved.
• As the surveys are expensive and time consuming there is a
tendency to limit the sample of the consumers. The sample selected
may not be very representative.
• Although the Time Series Analysis is used in forecasting cyclical
fluctuations, yet we cannot be sure about such forecasts because
there is no regular pattern of a business cycle. Different phases of
the cycle may have different intensities and timings which can make
the forecast go astray.
• Although efforts are made to use scientific methods in forecasting
yet there is bound to be difference between field experiments and
experiments conducted in laboratories.

Conclusions:

Demand forecasting allows retailers to make better decisions about which

prices to adjust and when, which products to promote, and what promotional
tactics to deploy, in order to achieve objectives. The benefits are significantly
more profound and productive than a simple sales forecast. The best informed
decisions will help increase profits, sales or market share—whatever the goal of
an industry.

After all, demand forecasting depends on the responses from the human
beings but the tastes and preferences of human beings keep changing. And thus
the application of even the quantitative or statistical models may not give us very
reliable forecast. Depending upon the resources and time the forecaster must use
more than one method to cross check the accuracy of his forecast.

Despite the limitations forecasting product demand is crucial to any

supplier, manufacturer, or retailer. Forecasts of future demand will determine the
quantities that should be purchased, produced, and shipped. In general practice,
accurate demand forecasts lead to efficient operations and high levels of
customer service, while inaccurate forecasts will inevitably lead to inefficient, high
cost operations and/or poor levels of customer service.