Demand Forecasting

Demand forecasting is predicting the future demand for the firm’s product.

Need for Demand forecasting:

 Planning and Scheduling production

 Acquiring inputs
 Making provisions for finances
 Formulating prices strategy
 Planning advertisement

Techniques of Demand Forecasting

Techniques in demand
forecasting

Survey Method Statistical Method

Consumer Survey: Opinion Poll Barometric Econometric

Direct Interview Method Trend Projection
Method Method

Regression

Regression analysis is a procedure commonly used to estimate consumer demand with available
data. The different types are time series, cross-section and panel. Demand forecasters begin a regression
analysis by identifying the factors or drivers of demand called independent, causal or explanatory
variables which they believe have influenced and will continue to influence the variable to be forecast,
the dependent variable. It is useful to categorize causal variables as internal or external. Internal variables,
also called policy variables, can be controlled to a substantial degree by managerial decisions, and their
future values can be set as a matter of company policy. Examples include product prices, promotion
outlays, and methods of distribution. External or environmental variables are those whose level and
influence are outside organizational control. This includes may be variables that measure weather and
holidays, demographics such as the age and gender of consumers in the market area, decisions made by
competing enterprises, and the state of the macro economy as measured by rates of economic growth,
inflation, and unemployment. Normally a regression analysis will attempt to account for both internal and
external causal variables.
 The forecaster’s beliefs about the way a dependent variable responds to changes in each of the
independent variables is expressed as an equation, or series of equations, called a regression model. A
regression model also includes an explicit expression of an error variable to describe the role of chance or
underlying uncertainty.

A model with a single independent variable is called a simple regression model. Multiple
regression refers to a model with one dependent and two or more independent variables.

History

A study made by Francis Galton, (1822-1911), which showed that whereas tall (or short) fathers
had tall (or short) sons, the sons were on average not as tall (or as short) as their fathers. This phenomenon
was called regression toward the mean. Thus, Galton observed that the average height of the sons tended
to move toward the average height of the overall population of fathers rather than toward reproducing
the height of the parents. It has since been observed in a wide spectrum of settings from economic
behavior and athletic performance to demand forecasting. Regression analysis is the principal method of
causal modeling in demand forecasting.

Linear Regression Analysis

ABC Inc. is in the business of selling cellular phones. It realized the advantages of forecasting very
early in its business. It also realized that in order to perform effective forecast, it needs to keep track of
its current and past sale numbers.

Currently, they are in the process of forecasting their sales for each quarter of the coming year. In order
to do this, they have pulled up their sales for the past 12 quarters. The numbers are as follows:

Quarter Sales (in units)

1 600
2 1550
3 1500
4 1500
5 2400
6 3100
7 2600
8 2900
9 3800
10 4500
11 4000
12 4900

Use the least-square method to find the forecast for the next 4 quarters. Also find the standard error of
the estimate.
Least square method is a form of mathematical regression analysis of the line of best fit for a data set. It
also provides for the visual demonstration of the relationship of variables.

𝑌 = 𝑎 + 𝑏𝑋

Where:

Y= dependent variable being solve (e.g. sale) b= slope

a= y intercept X= independent variable (e.g. Time)

Sales (units)
6000

5000
Sales being
4000 forecasted

3000

2000 Regression Line

1000

0
0 2 4 6 8 10 12 14

Quarter

𝑎 = Ȳ − 𝑏x̅

∑𝑋 − 𝑛Ȳx̅
𝑏=
∑ X² − 𝑛x̅ ²

Where:
a= y intercept n= sample size
b= slope of the line
Ȳ= mean of all Ys

x̅ = mean of all Xs
X values of the independent variable
Y= Values of the dependent variable

X Y XY X2
Quarter Sales (in
units)
1 600 600 1
2 1550 3100 4
3 1500 4500 9
4 1500 6000 16
5 2400 12000 25
6 3100 18600 36
7 2600 18200 49
8 2900 23200 64
9 3800 34200 81
10 4500 45000 100
11 4000 44000 121
12 4900 58800 144
78 33, 350 286, 200 650

𝑎 = Ȳ − 𝑏x̅

∑𝑋 − 𝑛Ȳx̅
𝑏=
∑ X² − 𝑛x̅ ²

∑𝑋 78
x̅ = =
12
= 6.5
𝑛

∑𝑌 33,350
Ȳ= = 12
= 2779.17
𝑛

268200 − 12(6.5 ∗ 2779.17)

𝑏=
650 − 12(6.5)²
𝒃 = 𝟑𝟓𝟗. 𝟔𝟏𝟑𝟓
𝑎 = Ȳ − 𝑏x̅
𝑎 = 2779.17 − 359(6.5)
 𝒂 = 𝟒𝟒𝟏. 𝟕𝟕𝟎𝟎

𝑌 = 𝟒𝟒𝟏. 𝟕𝟕𝟎𝟎 + 𝟑𝟓𝟗. 𝟔𝟏𝟑𝟓𝑿

𝑌₁₃ = 441.7700 + 359.6135(13)

𝑌₁₃ = 𝟓𝟏𝟏𝟔. 𝟓𝟕𝟎𝟎
𝑌₁₄ = 441.7700 + 359.6135(14)

𝑌₁₄ = 𝟓𝟔𝟒𝟕. 𝟏𝟕𝟎𝟎

𝑌₁₅ = 441.7700 + 359.6135(15)

𝑌15 = 𝟓𝟖𝟑𝟓. 𝟕𝟕𝟎𝟎

𝑌₁₆ = 441.7700 + 359.6135(16)
𝑌₁₆ = 𝟔𝟏𝟗𝟓. 𝟑𝟕𝟎𝟎

The forecasted sales for the next 4 years are 516.5700, 5647.1700, 5835.7700, 6195.3700 respectively.

Standard Error of the Estimate

Standard Error of the estimate provides an overall of how well the model fits the data. It
represents the average distance that the observed values fall from the regression line.
Smaller values are better because it indicates that the observation are closer to the fitted line.

∑(𝑌ⅈ − 𝑌ʹ)²
𝑠=√
𝑛−2

Where:

𝑌ⅈ= given value of the dependent variable

𝑌ʹ= value of the dependent variables computed from the equation

𝑛= sample size

X Y XY X2 Y’ (Y’-Y)2
Quarter Sales (in
units)
1 600 600 1 801.3700 40569.87
2 1550 3100 4 160.9700 15361.36
3 1500 4500 9 1520.5700 423.12
4 1500 6000 16 1880.1700 166529.22
5 2400 12000 25 2239.1200 25882.37
6 3100 18600 36 2599.3700 250630.39
7 2600 18200 49 2958.9700 128859.46
8 2900 23200 64 3318.5700 175200.84
9 3800 34200 81 3678.1700 14842.54
10 4500 45000 100 4037.7700 213656.57
11 4000 44000 121 4397.3700 157902.91
12 4900 58800 144 4756.9700 20957.58
78 33, 350 286, 200 650 1324279.21

𝑌 = 𝟒𝟒𝟏. 𝟕𝟕𝟎𝟎 + 𝟑𝟓𝟗. 𝟔𝟏𝟑𝟓𝑿 = 𝟒𝟒𝟏. 𝟕𝟕𝟎𝟎 + 𝟑𝟓𝟗. 𝟔𝟏𝟑𝟓(𝟏) = 𝟖𝟎𝟏. 𝟑𝟕𝟎𝟎

∑(𝑌ⅈ − 𝑌ʹ)²
𝑠=√
𝑛−2

1324279.21
𝑠=√
12 − 2

𝑠 = 363.8982
Alternative formula:

∑𝑌² − 𝑎∑𝑌 − 𝑏∑ 𝑋𝑌
𝑠=√
𝑛−2
∑𝑌² = 112502500

112502500 − 14733029.5 − 96444720

𝑠=√
10

𝑠 = 363.8982

Coefficient of determination (r2)

R-squared explains how good the model is when compared to the baseline model. It can take the value
between 0 and 1 where values to 0 represent poor fit while values closer to 1 represent a perfect fit.

How to interpret:

Example: r2= 0.96; 96% of the time the variation in the dependent variable Y are explained by the
independent variable X.

∑ (𝑌ʹ − Ȳ) ²
r² =
∑ (𝑌 − Ȳ) ²