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A demand forecast is the prediction of what will happen to your company's existing product
sales. It would be best to determine the demand forecast using a multi-functional approach. The
inputs from sales and marketing, finance, and production should be considered. The final
demand forecast is the consensus of all participating managers. You may also want to put up a
Sales and Operations Planning group composed of representatives from the different departments
that will be tasked to prepare the demand forecast.

Determination of the demand forecasts is done through the following steps:

‡ Determine the use of the forecast

‡ Select the items to be forecast

‡ Determine the time horizon of the forecast

‡ Select the forecasting model(s)

‡ Gather the data

‡ Make the forecast

‡ Validate and implement results

The time horizon of the forecast is classified as follows:

  


Short-range 
  

Duration Usually less than 3 3 months to 3 years More than 3 years
months, maximum of
1 year
Applicability Job scheduling, Sales and production New product
worker assignments planning, budgeting development,
facilities planning




 

There are two approaches to determine demand forecast ± (1) the qualitative approach, (2) the
quantitative approach. The comparison of these two approaches is shown below:
   






Applicability Used when situation is vague & Used when situation is stable &
little data exist (e.g., new products historical data exist
and technologies)
(e.g. existing products, current
technology)
Considerations Involves intuition and experience Involves mathematical techniques
Techniques Jury of executive opinion Time series models

Sales force composite Causal models

Delphi method

Consumer market survey




  

Your company may wish to try any of the qualitative forecasting methods below if you do not
have historical data on your products' sales.



   


   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.
!

   Each salesperson (for example for a territorial coverage) is
asked to project their sales. Since the salesperson is the one
closest to the marketplace, he has the capacity to know what
the customer wants. These projections are then combined at
the municipal, provincial and regional levels.
    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.
" 
# The customers are asked about their purchasing plans and
 their projected buying behavior. A large number of
respondents is needed here to be able to generalize certain
results.
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There are two forecasting models here ± (1) the time series model and (2) the causal model. A
time series is a s et of evenly spaced numerical data and is o btained by observing responses at
regular time periods. In the  , the forecast is based only on past values and
assumes that factors that influence the past, the present and the future sales of your products will
continue.

On the other hand, t he

 uses a mathematical technique known as the regression
analysis that relates a dependent variable (for example, demand) to an independent variable (for
example, price, advertisement, etc.) in the form of a linear equation. The time series forecasting
methods are described below:

 

$!

 
 
%
&
Assumes that demand in the m
 period is the same as demand in
  m period; demand pattern may not always be that stable

For example:

—  


 

 

 

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 MA is a series of arithmetic means and is used if little or no trend is
'( present in the data; provides an overall impression of data over time

A  

 uses average demand for a fixed

sequence of periods and is good for stable demand with no
pronounced behavioral patterns.

Equation:

)*+,-.-/01)
 F ± forecast, D ± Demand, No. ± Period

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2 

(

A   

 adjusts the moving average method to

reflect fluctuations more closely by assigning weights to the most
recent data, meaning, that the older data is usually less important.
The weights are based on intuition and lie between 0 and 1 for a
total of 1.0

Equation:

c)*'c('/(-'c('.(-'c(',(

WMA ± Weighted moving average, W ± Weight, D ± Demand, No.

± Period

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2  

(

3   
 The    
   is an averaging method that reacts
!   more strongly to recent changes in demand by assigning a
smoothing constant to the most recent data more strongly; useful if
recent changes in data are the results of actual change (e.g., seasonal
pattern) instead of just random fluctuations

-,*
-',
(

Where

F t + 1 = the forecast for the next period

D t = actual demand in the present period

F t = the previously determined forecast for the present period

‡ = a weighting factor referred to as the     


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2   
  (

$! The   adjusts the seasonality by
  multiplying the normal forecast by a seasonal factor



! 

 
Demand or sales forecasting is a scientific exercise. It has to go through a number of steps. At
each step, you have to make critical considerations. Such considerations are categorically listed
below:

,(%



: To begin with, you should be clear about the uses of forecast data- how it
is related to forward planning and corporate planning by the firm. Depending upon its use, you
have to choose the type of forecasts: short-run or long-run, active or passive, conditional or non-
conditional etc.

.(%

 : The next important consideration is the nature of product for which you
are attempting a demand forecast. You have to examine carefully whether the product is
consumer goods or producer goods, perishable or durable, final or intermediate demand, new
demand or replacement demand type etc. A couple of examples may illustrate the importance of
this factor. The demand for intermediate goods like basic chemicals is derived from the final
demand for finished goods like detergents. While forecasting the demand for basic chemicals, it
becomes essential to analyze the nature of demand for detergents. Promoting sales through
advertising or price competition is much less important in the case of intermediate goods
compared to final goods. The elasticity of demand for intermediate goods depends on their
relative importance in the price of the final product.

Time factor is a crucial determinant in demand forecasting. Perishable commodities such as fresh
vegetables and fruits can be sold over a limited period of time. Here skilful demand forecasting
is needed to avoid waste. If there are storage facilities, then buyers can adjust their demand
according to availability, price and income. The time taken for such adjustment varies from
product to product. Goods of daily necessities that are bought more frequently will lead to
quicker adjustments. Whereas in case of expensive equipment which is worn out and replaced
after a long period of time, adaptation of demand will be spread over a longer duration of time.

/(


: Once you have identified the nature of product for which you are
to build a forecast, your next task is to locate clearly the determinants of demand for the product.
Depending on the nature of product and nature of forecasts, different determinants will assume
different degree of importance in different demand functions.

In the preceding unit, you have been exposed to a number of price-income factors or
determinants-own price, related price, own income-disposable and discretionary, related income,
advertisement, price expectation etc. In addition, it is important to consider socio-psychological
determinants, specially demographic, sociological and psychological factors affecting demand.
Without considering these factors, long-run demand forecasting is not possible.

Such factors are particularly important for long-run active forecasts. The size of population, the
age-composition, the location of household unit, the sex-composition-all these exercise influence
on demand in. varying degrees. If more babies are born, more will be the demand for toys; if
more youngsters marry, more will be the demand for furniture; if more old people survive, more
will be the demand for sticks. In the same way buyers¶ psychology-his need, social status, ego,
demonstration effect etc. ±also effect demand. While forecasting you cannot neglect these
factors.

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4
: Identifying the determinants alone would not do, their
analysis is also important for demand forecasting. In an analysis of statistical demand function, it
is customary to classify the explanatory factors into (a) trend factors, which affect demand over
long-run, (b) cyclical factors whose effects on demand are periodic in nature, (c) seasonal
factors, which are a little more certain compared to cyclical factors, because there is some
regularly with regard to their occurrence, and (d) random factors which create disturbance
because they are erratic in nature; their operation and effects are not very orderly.

An analysis of factors is specially important depending upon whether it is the aggregate demand
in the economy or the industry¶s demand or the company¶s demand or the consumers; demand
which is being predicted. Also, for a long-run demand forecast, trend factors are important; but
for a short-run demand forecast, cyclical and seasonal factors are important.

5( "   
  6: This is a very important step. You have to choose a particular
technique from among various techniques of demand forecasting. Subsequently, you will be
exposed to all such techniques, statistical or otherwise. You will find that different techniques
may be appropriate for forecasting demand for different products depending upon their nature. In
some cases, it may be possible to use more than one technique. However, the choice of technique
has to be logical and appropriate; for it is a very critical choice. Much of the accuracy and
relevance of the forecast data depends accuracy required, reference period of the forecast,
complexity of the relationship postulated in the demand function, available time for forecasting
exercise, size of cost budget for the forecast etc.

7($ 

: This is the final step in demand forecasting. There are various methods for
testing statistical accuracy in a given forecast. Some of them are simple and inexpensive, others
quite complex and difficult. This stating is needed to avoid/reduce the margin of error and
thereby improve its validity for practical decision-making purpose. Subsequently you will be
exposed briefly to some of these methods and their uses.


$ 6


 
Broadly speaking, there are two approaches to demand forecasting- one is to obtain information
about the likely purchase behavior of the buyer through collecting expert¶s opinion or by
conducting interviews with consumers, the other is to use past experience as a guide through a
set of statistical techniques. Both these methods rely on varying degrees of judgment. The first
method is usually found suitable for short-term forecasting, the latter for long-term forecasting.
There are specific techniques which fall under each of these broad methods.

!! 8

For forecasting the demand for existing product, such survey methods are often employed. In this
set of methods, we may undertake the following exercise.

,(3 9  :: In this method, the experts on the particular product whose demand is
under study are requested to give their µopinion¶ or µfeel¶ about the product. These experts,
dealing in the same or similar product, are able to predict the likely sales of a given product in
future periods under different conditions based on their experience. If the number of such experts
is large and their experience-based reactions are different, then an average-simple or weighted ±
is found to lead to unique forecasts. Sometimes this method is also called the µhunch method¶ but
it replaces analysis by opinions and it can thus turn out to be highly subjective in nature.

.(;
 9   $ 6: This is a variant of the opinion poll method. Here is
an attempt to arrive at a consensus in an uncertain area by questioning a group of experts
repeatedly until the responses appear to converge along a single line. The participants are
supplied with responses to previous questions (including seasonings from others in the group by
a coordinator or a leader or operator of some sort). Such feedback may result in an expert
revising his earlier opinion. This may lead to a narrowing down of the divergent views (of the
experts) expressed earlier. The Delphi Techniques, followed by the Greeks earlier, thus generates
³reasoned opinion´ in place of ³unstructured opinion´; but this is still a poor proxy for market
behavior of economic variables.

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  : Under this, the forecaster undertakes
a complete survey of all consumers whose demand he intends to forecast, Once this information
is collected, the sales forecasts are obtained by simply adding the probable demands of all
consumers. The principle merit of this method is that the forecaster does not introduce any bias
or value judgment of his own. He simply records the data and aggregates. But it is a very tedious
and cumbersome process; it is not feasible where a large number of consumers are involved.
Moreover if the data are wrongly recorded, this method will be totally useless.

)(" !!
! : Under this method, the forecaster selects a few
consuming units out of the relevant population and then collects data on their probable demands
for the product during the forecast period. The total demand of sample units is finally blown up
to generate the total demand forecast. Compared to the former survey, this method is less tedious
and less costly, and subject to less data error; but the choice of sample is very critical. If the
sample is properly chosen, then it will yield dependable results; otherwise there may be sampling
error. The sampling error can decrease with every increase in sample size

5( 3    

 "  !: 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 demands for final consumption and exports net of imports are
estimated through some other forecasting method, and its demand for intermediate use is
estimated through a survey of its user industries.

" !

 8

We shall now move from simple to complex set of methods of demand forecasting. Such
methods are taken usually from statistics. As such, you may be quite familiar with some the
statistical tools and techniques, as a part of quantitative methods for business decisions.

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  : Under this method, the time series data on the under
forecast are used to fit a trend line or curve either graphically or through statistical method of
Least Squares. The trend line is worked out by fitting a trend equation to time series data with
the aid of an estimation method. The trend equation could take either a linear or any kind of non-
linear form. The trend method outlined above often yields a dependable forecast. The advantage
in this method is that it does not require the formal knowledge of economic theory and the
market, it only needs the time series data. The only limitation in this method is that it assumes
that the past is repeated in future. Also, it is an appropriate method for long-run forecasts, but
inappropriate for short-run forecasts. Sometimes the time series analysis may not reveal a
significant trend of any kind. In that case, the moving average method or exponentially weighted
moving average method is used to smoothen the series.

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 $ 6

 
 : This consists in discovering a set
of series of some variables which exhibit a close association in their movement over a period or
time.

For example, it shows the movement of agricultural income (AY series) and the sale of tractors
(ST series). The movement of AY is similar to that of ST, but the movement in ST takes place
after a year¶s time lag compared to the movement in AY. Thus if one knows the direction of the
movement in agriculture income (AY), one can predict the direction of movement of tractors¶
sale (ST) for the next year. Thus agricultural income (AY) may be used as a barometer (a leading
indicator) to help the short-term forecast for the sale of tractors.

Generally, this barometric method has been used in some of the developed countries for
predicting business cycles situation. For this purpose, some countries construct what are known
as µdiffusion indices¶ by combining the movement of a number of leading series in the economy
so that turning points in business activity could be discovered well in advance. Some of the
limitations of this method may be noted however. The leading indicator method does not tell you
anything about the magnitude of the change that can be expected in the lagging series, but only
the direction of change. Also, the lead period itself may change overtime. Through our
estimation we may find out the best-fitted lag period on the past data, but the same may not be
true for the future. Finally, it may not be always possible to find out the leading, lagging or
coincident indicators of the variable for which a demand forecast is being attempted.

/("
 
; : These involve the use of econometric methods to determine the
nature and degree of association between/among a set of variables. Econometrics, you may
recall, is the use of economic theory, statistical analysis and mathematical functions to determine
the relationship between a dependent variable (say, sales) and one or more independent variables
(like price, income, advertisement etc.). The relationship may be expressed in the form of a
demand function, as we have seen earlier. Such relationships, based on past data can be used for
forecasting. The analysis can be carried with varying degrees of complexity. Here we shall not
get into the methods of finding out µcorrelation coefficient¶ or µregression equation¶; you must
have covered those statistical techniques as a part of quantitative methods. Similarly, we shall
not go into the question of economic theory. We shall concentrate simply on the use of these
econometric techniques in forecasting.

We are on the realm of multiple regression and multiple correlation. The form of the equation
may be:

DX = a + b1 A + b2PX + b3Py

You know that the regression coefficients b1, b2, b3 and b4 are the components of relevant
elasticity of demand. For example, b1 is a component of price elasticity of demand. The reflect
the direction as well as proportion of change in demand for x as a result of a change in any of its
explanatory variables. For example, b2< 0 suggest that DX and PX are inversely related; b4 > 0
suggest that x and y are substitutes; b3 > 0 suggest that x is a normal commodity with commodity
with positive income-effect.

Given the estimated value of and bi, you may forecast the expected sales (DX), if you know the
future values of explanatory variables like own price (PX), related price (Py), income (B) and
advertisement (A). Lastly, you may also recall that the statistics R2 (Co-efficient of
determination) gives the measure of goodness of fit. The closer it is to unity, the better is the fit,
and that way you get a more reliable forecast.

The principle advantage of this method is that it is prescriptive as well descriptive. That is,
besides generating demand forecast, it explains why the demand is what it is. In other words, this
technique has got both explanatory and predictive value. The regression method is neither
mechanistic like the trend method nor subjective like the opinion poll method. In this method of
forecasting, you may use not only time-series data but also cross section data. The only
precaution you need to take is that data analysis should be based on the logic of economic theory.

')(!
36
  : Here is a very sophisticated method of forecasting. It is

also known as the µcomplete system approach¶ or µeconometric model building¶. In your earlier
units, we have made reference to such econometric models. Presently we do not intend to get
into the details of this method because it is a subject by itself. Moreover, this method is normally
used in macro-level forecasting for the economy as a whole; in this course, our focus is limited to
micro elements only. Of course, you, as corporate managers, should know the basic elements in
such an approach.

The method is indeed very complicated. However, in the days of computer, when package
programmes are available, this method can be used easily to derive meaningful forecasts. The
principle advantage in this method is that the forecaster needs to estimate the future values of
only the exogenous variables unlike the regression method where he has to predict the future
values of all, endogenous and exogenous variables affecting the variable under forecast. The
values of exogenous variables are easier to predict than those of the endogenous variables.
However, such econometric models have limitations, similar to that of regression method.