Demand forecasting and its techniques

Demand forecasting is the activity of estimating the quantity of a product or service that consumers will purchase. Demand forecasting involves techniques including both informal methods, such as educated guesses, and quantitative methods, such as the use of historical sales data or current data from test markets. Thus Demand forecasting may be used in: i. ii. iii. Making pricing decisions, In assessing future capacity requirements, or In making decisions on whether to enter a new market.

Kinds of Demand Forecasting: Description Short-range Duration Forecast Horizon Medium-range Long-range More than 3 years

Usually less than 3 3 months to 3 years months, maximum of 1 year

Applicability

Job scheduling, Sales and production New product worker assignments planning, budgeting development, facilities planning

The various Steps involved in Demand forecasting are: i. Nature of forecast: 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. Nature of product: whether the product is consumer goods or producer goods, perishable or durable, final or intermediate demand. Determinants of demand: Depending on the nature of product and nature of forecasts, different determinants will assume different degree of importance in different demand functions. Eg.: If more babies are born, more will be the demand for toys. Analysis of factors &determinants: Identifying the determinants alone would not do, their analysis is also important for demand forecasting. Choice of techniques: different techniques may be appropriate for forecasting demand for different products depending upon their nature. In some cases, it may be

ii. iii.

iv. v.

vi.

possible to use more than one technique. However, the choice of technique has to be logical and appropriate. Testing accuracy: This is the final step in demand forecasting. There are various methods for testing statistical accuracy in a given forecast.

Techniques of Demand Forecasting

There are two approaches to determine demand forecast (1) Qualitative approach, (2) Quantitative approach. No demand forecasting method is 100% accurate. Combined forecasts improve accuracy and reduce the likelihood of large errors.

Qualitative Forecasting Methods A company may wish to try any of the qualitative forecasting methods below if you do not have historical data on your products' sales. Qualitative Method Description

Jury of executive opinion 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. Sales force composite 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.

Delphi method

Consumer market survey 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. Quantitative Forecasting Methods 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 obtained by observing responses at regular time periods. In the time series model, 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 causal model 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:

Description

Time Series Forecasting Method Nave Approach Assumes that demand in the next period is the same as demand inmost recent period; demand pattern may not always be that stable For example: If July sales were 50, then Augusts sales will also be 50

Description Time Series Forecasting Method Moving Averages MA is a series of arithmetic means and is used if little or no trend is (MA) present in the data; provides an overall impression of data over time A simple moving average uses average demand for a fixed sequence of periods and is good for stable demand with no pronounced behavioral patterns. Equation: F 4 = [D 1 + D2 + D3] / 4 F forecast, D Demand, No. Period (see illustrative example simple moving average) A weighted moving average 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: WMA 4 = (W) (D3) + (W) (D2) + (W) (D1) WMA Weighted moving average, W Weight, D Demand, No. Period (see illustrative example weighted moving average)

Exponential Smoothing

The exponential smoothing 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 F t + 1 = a D t + (1 - a ) F t 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 smoothing constant (see illustrative example exponential smoothing)

Time Series The time series decomposition adjusts the seasonality Decomposition multiplying the normal forecast by a seasonal factor (see illustrative example time series decomposition)

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