What is Demand Forecasting?
The art of predicting the demand for a service or product in the future market is known as demand forecasting. This forecast is based on historical data, past customer behavior trends, and patterns of the present market. In short, it is the scientific estimation of future demand for products and not just merely guessing it. It also gives crucial insights into cash flows, risk maintenance, budgeting, margins, inventory turnover, and more. There is no perfect demand forecasting method so every company needs a prediction solution. Here we shall discuss some of those methods. The efficiency of these methods can be increased by making them more accurate with the application of various methodologies.
Various Demand Forecasting Methods
Forecasting the demand is not easy. Proper scientific formulas and sound judgment are required to accurately forecast the demand for a service or product in the future. Let us take a look at the various methods of demand forecasting.
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Method of Collective Opinion
Here the estimated sales for the future are predicted by the salesperson of a firm, from a particular region. All these individual estimates are combined to calculate the total estimated sales. The consumers are closest to the salesperson. Hence it is believed that they would understand the needs and trends amongst customers much better.
The estimates are based on market competition, product usage, customer behavior, advertisements, the population of the region, and more. This method is not scientific as it depends on the experience of the salesperson and his personal opinions on customer relations.
Barometric Method
This method uses the projection of past demand for products and services into the future. The future trends are predicted with the help of economic indicators. The various types of economic indicators include lagging indicators, leading indicators, and coincident indicators.
The ones that move up or down in the lead of some other series are the leading indicators. The ones that follow the change after a time gap are the lagging indicators. While the ones that move up and down depending on economic activities are the coincident indicators.
Method of Expert Opinion
Demand forecasting can also be done with the help of the market experts as they know about the demand affecting factors in detail. The Delphi Technique is one such method. It is a pretty reasonable and speedy technique where the experts are provided with a critical questionnaire from which they are supposed to forecast the demand. They are provided with data to conclude. However, they are also required to provide suitable reasons for how they concluded.
Method of Market Experimentation
This method is a time-consuming and expensive one in which market studies are conducted based on consumer trends and patterns. Certain factors are considered constant as some determinants may vary while doing calculations.
Buyer's Choice Survey
One of the best demand forecasting methods is asking the customers about the needs and expectations regarding the kind of products they are expecting. Whenever the forecast is to be made within a short period, customers should be directly interviewed. On the other hand, businesses should not depend on customer views as they may misjudge the demands or change their preferences with time. Hence, use your judgment while forecasting also.
Statistical Methods
These are the most bias-free, reliable, and scientifically proven methods. The two most famous types of statistical methods are trend projection and regression analysis methods. These are entirely dependent on future demand predictions.
Major Types of Demand Forecasting
Demand forecasting can be done in various different ways and you may choose any type of demand forecasting method and can perform it using any method that the company desires. The six major types of demand forecasting are
Passive Demand Forecasting: In this type of forecasting, sales data from the past is used to predict the future of the company. In case of seasonal fluctuations, be sure that you use data from the same season in order to project sales in the future. It is one of the simplest and easier methods for demand forecasting.
Active Demand Forecasting: This type of demand forecasting is a good choice for new start-ups. This model takes marketing campaigns, market research, and expansion plans into account.
Short-Term Projections: This forecasting method analyzes for a short-term of 3 to 12 months helps in managing a just-in-time supply chain and also allows the company to adjust their projections based on real-time sales data.
Long-Term Projections: This forecasting method analyzes for a long-term of one to four years and helps us in focusing and shaping the growth of business trajectory, planning out the company’s marketing, capital investments, and supply chain operations. The method is based on sales data and market research.
External Macro Forecasting: This company incorporates the trends that persist in a broader economy, that is, it analyzes how the trends affect the goals of a company and give us a direction that can help us meet our career goals.
Internal Business Forecasting: Internal capacity is one of the limiting factors for the growth of your business. This type of forecasting helps you predict the limitations that might slow down the growth of your business. It also helps reveal the untouched areas of opportunity within the organization. The major factors in internal forecasting are business financing, profit margins, cash on hand, and supply chain operations. Therefore, this forecasting helps you make realistic projections and gives you time to build the capacity that can help you meet expansion goals.
How Can We Create Forecasts?
There are many different ways that can be utilized to create forecasts. The five major methods used for making demand forecasts are:
Trend Projection: It is the simplest and most straightforward method to forecast demand that involves the use of previous sales data in order to predict future sales. It is an example of passive demand forecasting.
Market Research: This type of forecasting is based on the data that is collected through customer surveys. The method is time-consuming and tedious as one needs to send surveys to the customer and then tabulate data accordingly. The information gathered from this method cannot be collected from any other method, therefore, the efforts required by this method are worth it. It is an example of active demand forecasting.
Salesforce Composite: This method utilizes the feedback obtained from the sales group in order to forecast the demands of the customer. The method also helps in connecting the sales division with the managers of the company to keep the flow of information open. It is an example of short-term projections.
Delphi Method: This method involves experts and skilled facilitators from outside in order to obtain an expert opinion on the market forecast of your company.
Econometric: This method involves the use of mathematical formulas to predict the future of customer demand. The method is based on the relationship between various economic factors that can affect the demand for a certain company’s products.
Solved Examples
1. What are the major types of Statistical Forecasting?
Statistical Forecasting is basically of six types in general. They are linear regression, multiple linear regression, time series analysis, productivity ratios, and stochastic analysis.
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2. Name four common types of forecasting.
The main four forms of forecasting are econometric models, the Delphi method, judgmental forecasting, and the time series model.
Fun Facts
Forecasting is broadly classified into qualitative and quantitative forecasting.
Cash flow statements, income statements, and balance sheets are the three fundamental components of financial forecasting.
Often we tend to apply wrong planning for strategic decision making. These are some of the biggest challenges in demand forecasting.
It is not like only the customers need the products; the business also needs the customers. Hence, they continuously interact with their consumers to make them happy and satisfy their needs. This place is where survey forecasting comes into play.
FAQs on Methods of Demand Forecasting: Explained
1. What is demand forecasting and why is it important for a business?
Demand forecasting is the scientific process of estimating the future demand for a company's products or services. It uses historical sales data and market trends to make predictions. It is crucial for businesses because it provides insights for budgeting, managing cash flows, optimising inventory, planning production, and making strategic decisions about growth and market expansion.
2. What are the main methods of demand forecasting used in business?
The main methods of demand forecasting can be broadly categorised into qualitative and quantitative approaches. Key methods include:
- Survey Methods: Involves collecting information directly from consumers about their purchasing intentions, either through a complete survey or a sample survey.
- Opinion Poll Methods: Gathers opinions from those with market expertise, such as salespeople (Salesforce Composite method) or external experts (Delphi Technique).
- Market Experiment Methods: Involves conducting controlled market studies to see how consumers react to changes in product price or advertising.
- Statistical Methods: Uses past data to predict future demand. Common techniques include Trend Projection and Regression Analysis.
- Barometric Method: Uses economic indicators (leading, lagging, and coincident) to predict trends in demand.
3. What are the different types of demand forecasting based on time frame and business activity?
Demand forecasting can be classified into several types based on the business's goals and timeline:
- Passive Demand Forecasting: A simple method that relies on past sales data to project future sales, often used by stable businesses.
- Active Demand Forecasting: A more comprehensive approach suitable for growing businesses, which considers factors like marketing campaigns, market research, and expansion plans.
- Short-Term Projections: Forecasts demand for a period of 3 to 12 months, used for managing inventory and supply chains.
- Long-Term Projections: Looks ahead 1 to 4 years, guiding major strategic decisions like capital investment and market entry.
- Internal Business Forecasting: Focuses on a company's internal capacity, such as production capabilities and financing, to set realistic growth goals.
- External Macro Forecasting: Analyses broader economic trends, like inflation or consumer spending habits, and their potential impact on the company's demand.
4. Can you explain the statistical methods of demand forecasting with examples?
Statistical methods are quantitative techniques considered reliable and scientific. The two main methods are:
- Trend Projection: This method arranges historical sales data chronologically to identify a long-term trend. For example, if a company's sales have consistently grown by 5% each year for the last 5 years, this trend is projected into the future to forecast sales. It assumes past trends will continue.
- Regression Analysis: This method establishes a mathematical relationship between the quantity demanded (dependent variable) and factors that influence it, like price, income, or advertising spend (independent variables). For example, a company might use the equation Y = a + bX, where Y is the forecast demand, X is the advertising budget, and 'a' and 'b' are constants derived from past data.
5. How does the Delphi Technique ensure an unbiased expert opinion in forecasting?
The Delphi Technique is designed to reduce the influence of groupthink and individual bias. It works by anonymously surveying a panel of experts using a structured questionnaire. The experts provide their forecasts along with justifications. A facilitator then compiles the results, shares the anonymised summary (including reasons for different opinions) with the panel, and allows them to revise their forecasts in a second round. This iterative process continues until a consensus is reached, ensuring the final forecast is a well-reasoned and balanced outcome rather than the opinion of the most vocal expert.
6. What is the fundamental difference between qualitative and quantitative demand forecasting?
The fundamental difference lies in the type of data used. Quantitative forecasting relies on historical numerical data and uses mathematical and statistical models (like Trend Projection or Regression Analysis) to predict future demand. It is objective and best for stable situations with available past data. In contrast, qualitative forecasting is subjective and relies on the judgment and opinions of experts or consumers (like the Delphi Technique or consumer surveys). It is most useful when historical data is scarce or irrelevant, such as when launching a new product or entering a new market.
7. In what situations would a business choose a short-term projection over a long-term one?
A business would choose a short-term projection (3-12 months) for tactical and operational decisions. It is ideal for managing a just-in-time supply chain, planning production schedules, managing workforce levels, and adjusting marketing tactics based on recent sales data. A long-term projection (1-4 years) is used for strategic decisions, such as planning for capital investments, entering new markets, or developing new product lines that require significant time and resources.
8. What are the common limitations a business might face when implementing demand forecasting?
Even with sophisticated methods, businesses face several common limitations:
- Lack of Historical Data: New businesses or companies launching new products often lack the past sales data required for accurate quantitative forecasting.
- Changing Market Conditions: Unforeseen events, new competitors, or rapid changes in consumer preferences can make past data an unreliable predictor of the future.
- Cost and Time: Detailed methods like market experiments or extensive surveys can be expensive and time-consuming to conduct.
- Subjectivity: Qualitative methods, while useful, can be influenced by the personal biases of the experts or consumers being surveyed.
9. How does demand forecasting directly influence a company's financial planning?
Demand forecasting is a cornerstone of financial planning. An accurate forecast of future sales directly influences the revenue projections in the company's budget. This, in turn, helps in estimating future cash flows, determining the need for working capital, and planning for major expenditures. For instance, forecasting high demand might signal the need to secure additional financing for increased production, while forecasting a slump might require creating a more conservative budget and cutting costs.
