DEMAND FORECASTING

DEFINITION—

Forecasting is defined as a study with scientific prediction in regard to an event which may
have future demand for goods, services either at the macro level. Forecasting deals with the
likely shape of future events. It is scientific guesswork. Demand forecasting means estimate
of expected future demand conditions.

Forecasting is useful for managerial decision making, effective planning. It helps to assess
the probable demand for goods and services in different period of time. Demand forecasting
translates the demand functions into quantitative guesses. A theoretical demand functions
seeks to include all the forces that influence sales.

If these are to be translated into actuality, some of the demand determinants have to be
selected and a formula for forecasting sales has to be evolved. This is a function of demand
forecasting. Since the management operates under conditions of uncertainty; a probable
estimate of future demand for the products is absolute minimum.

Forecasting is required in all areas enterprise. Since future is uncertain, no forecast is hundred
percent certain. However, it is necessary for every firm to make forecast as correct as
possible. Henry fayol was the first to lay emphasis on forecasting as an important function of
business management. A good forecast reduces the shape of uncertainty to the barest
minimum.

Demand forecasting is also helpful in better planning and allocation of national resources.
Because of unrealistic estimate of projected demand and production India had to spend in
1978 Rs 1,000 corers on imports even essential goods.

A Demand forecasting is the prediction of what will happen to your company’s existing
product sales. It would be best to determine forecast using a multi-functional approach. The
inputs from sales and marketing, finance, and production should be considered. The final
demand forecast is the consensus of all participating managers.

The National council of Applied Economics Research has made demand forecasts for a
number of products (consumer as well as industrial) on macro-level.These forecasts can be
helpful in determining industry demand.
 SIGNIFICANCE OF DEMAND FORECASTING
Forecasting product demand is crucial to any supplier, manufacturer, or retailer. Forecasts of
future demand will determine the quantities that should be purchased, produced, and shipped.
Demand forecasts are necessary since the basic operations process, moving from the
suppliers' raw materials to finished goods in the customers' hands, takes time. Most firms
cannot simply wait for demand to emerge and then react to it. Instead, they must anticipate
and plan for future demand so that they can react immediately to customer orders as they
occur. In other words, most manufacturers "make to stock" rather than "make to order" – they
plan ahead and then deploy inventories of finished goods into field locations. Thus, once a
customer order materializes, it can be fulfilled immediately – since most customers are not
willing to wait the time it would take to actually process their order throughout the supply
chain and make the product based on their order. An order cycle could take weeks or months
to go back through part suppliers and sub- assemblers, through manufacture of the product,
and through to the eventual shipment of the order to the customer.

Firms that offer rapid delivery to their customers will tend to force all competitors in the
market to keep finished goods inventories in order to provide fast order cycle times. As a
result, virtually every organization involved needs to manufacture or at least order parts based
on a forecast of future demand. The ability to accurately forecast demand also affords the
firm opportunities to control costs through levelling its production quantities, rationalizing its
transportation, and generally planning for efficient logistics operations.

In general practice, accurate demand forecasts lead to efficient operations and high levels of
customer service, while inaccurate forecasts will inevitably lead to inefficient, high cost
operations and/or poor levels of customer service. In many supply chains, the most important
action we can take to improve the efficiency and effectiveness of the logistics process is to
improve the quality of the demand forecasts.
 METHODS OF DEMAND FORECASTING
Demand forecasting methods are classified into:

(1) Survey methods

(2) Statistical methods

Survey methods are classified into:

(1) Survey of expert opinions poll

(2) Reasoned Opinion – Delphi technique
(3) Consumer Survey- Complete Enumeration Method
(4) Consumer Survey-Sample Survey Method
(5) End-user Method of Consumers Survey

Statistical methods are classified into

(1) Barometric methods

(2) Time series analysis or trend method
(3) Correlation and Regression method
(4) Simultaneous Equations Method

Statistical methods use past behaviour of sales as a guide and by extrapolating past statistical
relationship and predict the future demand. The demand for established products can be
forecast either by survey methods, but for new products, survey method is the only source.

Survey methods are explained as follows:-

(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 behaviour of economic variables.

(3) Consumer 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-user 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.

Statistical Methods Are Explained as:-

(1)Barometric methods -This consists in discovering a set of series of some variables which
exhibit a close association in their movement over a period of time.Generally, this barometric
method has been used in some of the developed countries for predicting business cycles
situation. For this purpose, some countries construct what are known as ‘diffusion indices’ by
combining the movement of a number of leading series in the economy so that turning points
in business activity could be discovered well in advance. Some of the limitations of this
method may be noted however. The leading indicator method does not tell you anything
about the magnitude of the change that can be expected in the lagging series, but only the
direction of change. Also, the lead period itself may change overtime. Through our estimation
we may find out the best-fitted lag period on the past data, but the same may not be true for
the future. Finally, it may not be always possible to find out the leading, lagging or coincident
indicators of the variable for which a demand forecast is being attempted.

(2)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.

(3)Correlation and Regression method- 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.

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.