Demand Forecasting
Meaning, Scope, Types, Importance, Limitations and Criteria for Good Decision Making
A forecast is a prediction about a future event which is most likely to happen under given conditions. In a world full of uncertainties, formation of some view about the future is inevitable. Therefore, firms try to forecast the likely demand for their products. Predictions of future demand for a firm’s product or products are known as demand forecasts. Demand forecasts are important because huge resources are involved in the modern large-scale production. It has come to be reckoned as an important function of management. The aim of economic forecasting is to reduce the risk or uncertainty that the firm faces in its short term operational decision making and in planning for its long term growth. Thus, good forecasting becomes a key factor in a firm’s success. The unstable the demand, the more critical is forecast accuracy, and the more elaborate is the more forecasting procedure.
We can thus define demand forecasting as the scientific and analytical estimation of demand for a product (good or service) for a particular period of time. It is the process of determining how much of which product is needed when and where.
According to American Marketing Association
Demand Forecasting is an estimate of sales in dollars or physical units for a specified future period under a proposed marketing plan.
Nature and Scope of Demand Forecasting
Savage and small have served a warning in respect of demand forecasting; because they fear that demand forecasting is likely to be construed to mean many things. Similarly it is possible to use a demand forecast in a number of ways. It is therefore necessary, in their opinion, to outline the nature and the scope of demand forecasting. In the opinion of these authors, consideration of the following factors is important as they demarcate the scope of demand forecasting.
1. Time-frame
A firm has to be certain about the time-frame for which it needs a forecast. In this context every firm has to first decide upon the period of time. Whether the firm chooses a 3 year period or 5-year period or still longer period is important, because the conveniences and inconveniences of the methods of demand forecasting to be used by the firm depending upon the time frame .
(a) Short-term forecasts
Normally, a period of one year is considered to be short-term for demand-forecasting. Short-term forecasts can be reasonably accurate because internal policies of the firm (like sales promotion) or external policies (like tax policies of the government) do not change during such a short period. Short term forecasts can be based on current experiences and opinions of the people who know.
(b) Long-term forecasts
When a new plant is to be erected or an existing one is to be expanded, a firm needs to take into account a period ranging from 5 to 10 years. Such forecasts have to depend upon statistical methods and more elaborate exercises of demand forecasting.
(c) Secular forecast
Secular demand forecasts refer to still longer period where secular factors, influencing demand become more relevant. These include factors like population growth, economic development, changes in the direction and composition of international trade or political developments in the country and so on. Thus, the decision regarding the time-frame for the forecast occupies an important place in demand-forecasting.
2. Level of forecasts
Demand forecasts can be prepared on various levels.
(a) Level of the economy
Entrepreneurs can have their own forecasts based upon total national output or gross national product, the indices of which can be available to them.
(b) Level of the industries
At the level of industries, demand forecasts are usually prepared by business associations like chambers of commerce and industries. Forecasts regarding prospects of an industry and future demand for the product of an industry can be formulated on the basis of market surveys, past trends in demand and other statistical methods. Industry level forecasts are useful to every member firm because every firm can compare its own position vis-a-vis the position of the Industry.
(c) Level of a firm
On the level of a firm one prepares demand forecasts from the point of view of an individual firm. It is this level of forecast which occupies an important place in microeconomic analysis.
3. General and specific forecasts
Many times demand forecasts are prepared in general for -all the products of a firm. Such forecasts have their own uses. However, a firm needs a more detailed information regarding an extent or demand in a particular region or the quantum of demand for each individual product. This requires specific forecast. Too many details may blur the overall picture and just an over-all picture based on general forecast is of little use to the firm. This fact must be remembered while preparing general as well as specific forecasts.
4. Established Products and New Products
Forecasting demand for established products must be placed on different footing, since these products are already being produced. Knowledge of the current level of the demand for these products and present competition in this field, can be an advantage to the firm for using statistical methods of demand-forecasting. This is not possible in respect of new products. So’ for forecasting the demand for new products, one has to use different methods and face different problems.
5. Classification of Products
While preparing demand forecasts, it is necessary to classify the products concerned into capital goods, consumer goods, and durable consumer goods, because each of these classes of goods faces a different type of demand. The demand for capital goods is a derived demand and faces severe fluctuations. The demand for durable consumer goods can be postponed and therefore falls suddenly during depression. The demand for consumer goods is related to the income of the people. With an increase in income, the demand for consumer goods increases, but a fall in consumer’s income is not immediately followed by a decrease in demand in the same proportion.
6. Special Factors
Each demand forecast has to take into account, special factors relating to every product and the market for every product, the nature of competition, the extent of uncertainty, unforeseen risks, and possibilities of forecasts going wrong are some of these special factors. These factors influence the demand differently, at different places and at different times. Similarly there are product-wise differences in the combinations of such special factors entering into demand forecasts. For example, changes in fashion is a special factor that enters into the demand forecast for ready-made garments. Intense competition is a factor to be considered by producers of cosmetics, while weather forecasts are an important factor for producers of umbrellas, rain-coats and air-coolers.
Types of Demand Forecasting
Demand forecasting can be categorized on the basis of :
(i) Level of Forecasting
(ii) Time Period
(iii) Nature of goods
i. On the Basis of Level of Forecasting
Firm (Micro) level: This refers to forecasting of demand for its product by an individual firm. It is the most important category of forecasting from the manager’s viewpoint to take various important decisions related to production and marketing.
Industry level: This is forecasting of demand for a product in an industry as a whole. It provides insight into the growth pattern of the industry and is also helpful in identifying the life cycle stage of the product. Industry level forecasting provides an insight into the relative contribution of the industry in national income.
Economy (Macro) level: This refers to forecasting of aggregate demand (or output) in the economy as a whole. This helps in various policy formulations at government level.
ii. On the Basis of Time Period
Short term forecasting: This refers to demand forecasting for a period not exceeding a year. In the short run the manager has to select different levels of the variable input to combine with the fixed input, in order to optimise the level of production. The main focus of such forecasting is on the short term production decisions of any firm to avoid over production or under production. It helps in taking decision regarding inventory, cost on variable factors, sales targets and appropriate pricing.
Long term forecasting: Long term forecasting facilitates long term decisions such as capacity expansion (reduction), new plant, new product, wider product range etc. It may have a time horizon of 5 to 7 years and may extend up to 10 to 20 years. Long term forecasting helps in manpower planning, long term capital requirement, and investment decisions. At macro level it determines interdependence of industries.
iii. On the basis of Nature of Goods
Consumer Goods: Demand forecasting is indispensable for consumer goods. For durable consumer goods demand forecasting can be for new demand or replacement demand, for which long term demand forecasting may be more useful. For non durable goods demand would vary with income level, social status, sex, age, education and occupation of the consumers, and price of the product. Short run demand forecasting would be relevant for forecasting demand for non durable consumer goods.
Capital Goods: Capital goods are demanded for further production and thus they have derived demand. This in turn implies dial demand for such goods depends upon demand for consumer goods which they can produce. This category of demand forecasting is highly complex but very’ important for long term growth.
