DEMAND FORECASTING

Concepts of Forecasting:
The manager can conceptualize the future in definite terms. If he is concerned with future event- its
order, intensity and duration, he can predict the future. If he is concerned with the course of future
variables- like demand, price or profit, he can project the future. Thus prediction and projection-both
have reference to future; in fact, one supplements the other. Suppose, it is predicted that there will be
inflation (event). To establish the nature of this event, one needs to consider the projected course of
general price index (variable). Exactly in the same way, the predicted event of business recession has
to be established with reference to the projected course of variables like sales, inventory etc.
Projection is of two types forward and backward. It is a forward projection of data variables, which
is named forecasting. By contrast, the backward projection of data may be named back casting, a
tool used by the new economic historians. For practical managers concerned with futurology, what is
relevant is forecasting, the forward projection of data, which supports the production of an event.
Thus, if a marketing manager fears demand recession, he must establish its basis in terms of trends in
sales data; he can estimate such trends through extrapolation of his available sales data. This trend
estimation is an exercise in forecasting.
Need for 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 planningall 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 noforecasting. 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.
Steps in Demand Forecasting:
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:
1) Nature of forecast: 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.
2) Nature of product: 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..
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.
3) Determinants of demand: 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.
Such factors are particularly important for long-run active forecasts. The size of population, the agecomposition, 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.
4) Analysis of factors &determinants: 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.
.
5) Choice of techniques: 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.
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 experts 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. The sampling error can decrease with
every increase in sample size
5) End-use Method of Consumers Survey: 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.

Complex Statistical Methods:

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.
(1) 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.
2) 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
You know that the regression coefficients b 1, 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 incomeeffect.
Given the estimated value of and b i, you may forecast the expected sales (D X), if you know the future
values of explanatory variables like own price (P X), 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.
(4) Simultaneous Equations Method: Here is a very sophisticated method of forecasting. It is also
known as the complete system approach or econometric 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.
Thus we may conclude that each and every method has its own merits and demerits and we need to
bare in mind this when we select a particular tool.