DEMAND FORECASTING

Business managers, depending upon their functional area, need various

forecasts. They need to forecast demand, supply, price, profit, costs, investment,
and what have you. In this unit, we are concerned with only demand
forecasting. The reason is, the concepts and techniques of demand forecasting
discussed here can be applied anywhere.
The question may arise: Why have we chosen demand forecasting as a model?
What is the use of demand forecasting?
The significance of demand or sales forecasting in the context of business
policy decisions can hardly be overemphasized. Sales constitute the primary
source of revenue for the corporate unit and reduction for sales gives rise to
most of the costs incurred by the fir.

Thus sales forecasts are needed for production planning, inventory planning,
profit planning and so on. Production itself requires the support of men,
materials, machines, money and finance, which will have to be arranged. Thus,
manpower planning, replacement or new investment planning, working capital
management and financial planning—all depend on sales forecasts. Thus
demand forecasting is crucial for corporate planning. The survival and growth
of a corporate unit has to be planned, and for this sales forecasting is the most
crucial activity. There is no choice between forecasting and no-forecasting. The
choice exists only with regard to concepts and techniques of forecasting that we
employ. It must be noted that the purpose of forecasting in general is not to
provide an exact future data with perfect precision, the purpose is just to bring
out the range of possibilities concerning the future under a given set of
assumptions. In other words, it is not the ‘actual future’ but the ‘likely future’
that we build up through forecasts. Such forecasts do not eliminate, but only
help you to reduce the degree of risk and uncertainties of the future. Forecasting
is a step towards that kind of ‘gursstimation’; it is some sort of an
approximation to reality. If the likely state comes close to the actual state, it
means that the forecast is dependable. If not, it is meaningless. A sales forecast
is meant to guide business policy decision. Without forecasting, forward
planning by a corporate unit will be directionless.
Techniques of Demand Forecasting:
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.
We shall now taker up each one of these techniques under broad category of
methods suggested above.
Simple Survey Method:
For forecasting the demand for existing product, such survey methods are often
employed. In this set of methods, we may undertake the following exercise.

1) Experts’ Opinion Poll: In this method, the experts on the particular product
whose demand is under study are requested to give their ‘opinion’ or ‘feel’
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 ‘hunch method’ but it replaces analysis by opinions and it can thus
turn out to be highly subjective in nature.
2) Reasoned Opinion-Delphi Technique: 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 “reasoned opinion” in place of “unstructured
opinion”; but this is still a poor proxy for market behavior of economic
variables.
3) Consumers’ Survey- Complete Enumeration Method: 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.

4) Consumer Survey-Sample Survey Method: 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.
5)Time series analysis or trend method: 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.
6) Correlation and Regression: 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 ‘correlation coefficient’ or ‘regression 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