Demand Forecasting | Meaning, Types, Objectives, Approach

What is Demand Forecasting?

A forecast is an estimate of a future situation. Forecasting demand denotes an estimation of the level of demand of the product at a future period under given circumstances. To put it very simply, it is an “objective assessment of the future course of demand“.

Demand Forecasting
Demand Forecasting

Demand forecasting is of great importance in business planning and the entrepreneurs have to plan for the future business by estimating the future situation. This is essential for a firm to enable it to produce the required quantities at the right time and push them in the market. Forecasting helps a firm to assess the probable demand for its products and plan its production accordingly.

Forecasting of demand vs Forecasting of Sales

Though forecasting of demand and forecasting of sales mean the same thing in general discussion, economists try to differentiate between the two terms on slender technical grounds.

Forecasting sales may be important from estimating revenue, cash requirement and expenses. There may be-time lag between “demand” and “sales”,i.e., between “customer order” and “billing”. The distributive system in the firm may not be able to cope with the volume of demand.

Hence the concept of demand forecasts is related to production, inventory control, timing, reliability of forecast, etc. However, there is not much difference in using these terms as interchangeable.

Demand forecasting is very popular in industrially advanced countries where demand is the limiting factor. But in less developed and developing countries, like India, supply is the limiting factor. High prices and black markets create bottlenecks in the marketing system. Hence, in these countries, supply forecasting seems to be more important than demand forecasting.

Types of Forecasting

From the point of view of “time span”, forecasting may be classified into two, viz.,

  1. Short-term demand forecasting; and
  2. Long-term demand forecasting.
Short-term and Long-term Forecasting
Short-term and Long-term Forecasting

1. Short-term Demand Forecasting

This is limited to short period not exceeding one year. It concerns with policies relating to sales, purchases, pricing and finances. It is with reference to the existing production capacity of the firm.

Short-term demand forecasting is useful in taking adhoc decisions concerning the day-to-day working of the concern. Many companies use forecasting for setting sales targets and for establishing controls and incentives. Knowledge of the short-term forecasting helps in short-term planning.

2. Long-term forecasting

Long-term forecasting involves the assessment of long term demand for the product and involves expansion of production units. A multi-product firm must ascertain not only the total demand situation, but also the demand for different items.

Long-term forecasting involves the study of technological developments, economic trends and consumer preferences and man-power planning, Long-term forecasting enables to take major strategic business decisions.

When forecasts covering long periods are made, the probability of error may be high. Hence, quality and competent forecasting are essential requirements for this type.

The following comparative statement shows the difference in purpose between short-term forecasting and long-term forecasting.

Short-term Forecasting Long-term Forecasting
1. Adhoc decision 1. Major strategic decisions
2. Evolving suitable production and Sales policies 2. Planning for new units and expanding the existing units
3. Determining purchase planning to reduce cost of production 3. Long-term financial planning
4. Determining Price Policy 4. Man-power planning
5. Fixing Sales Targets 5. Reliance on statistical techniques
6. Establishing controls and creating incentives
7. Determining financial requirements
8. Experience and information used in judgement and decision-making

Prof. Christopher, I. Savage and John R.Small classify demand and sales forecasting at different levels. They are:

  1. Macroeconomic forecasting
  2. Industry forecasting
  3. Micro level forecasting

1. Macroeconomic forecasting

Macroeconomic forecasting is concerned with business conditions over the whole economy, usually measured by appropriate index or estimate of industrial production, National Income or expenditure, etc.

2. Industrial level forecasting

Industrial level forecasting is made available by trade association or Chamber of Commerce to its members. These are based on surveys of consumer’s intentions and analyses of statistical trends. A firm can make use of these data for comparison with the industry.

3. Micro level forecasting

Micro level forecasting is related to an individual firm about which we are concerned. Whenever we say “forecasting”, it is only in relation to a firm in our discussions.

Forecasts may be either Passive or Active.

  • Passive forecasts contemplate the future situation in the wake of any consideration for the action by the firm.
  • Active forecasts predict the future situation giving due consideration to the future action of the firm.

Forecasts may be general or specific. It may relate to different commodities or specific areas. Many firms require separate forecasts for home and export market.

Forecasting usually differ for new products from those for products already well-established in the market, for which sale trends are already known. There arc different forecasts for different types of products like capital good, consumer durable, etc.

Objectives and Purposes of Forecasting

Objectives of Forecasting
Objectives of Forecasting

Forecasting demand is very essential for a firm, as it is very helpful in many ways formulating several policies of the firm. The objectives and purposes of forecasting can be listed under two categories, viz.,

  1. Objectives and purpose of short-term forecasting
  2. Objectives and purpose of long-term forecasting.

1. Objectives of short-term forecasting

1. Short-term forecasting helps in framing suitable production policy. There is a time-lag between production and consumption. If the demand for the product has not been assessed well in advance, there may be possibilities of over-production or under-production of the product. To formulate appropriate scheduling of production, demand forecasting is very essential.

2. The firm requires proper management of inventories, i.e., purchasing of raw materials at appropriate time when their prices are low and also avoiding over stocking. Forecasting is essential for framing suitable purchase policy.

3. Evolving suitable price policy, so as to have effective price strategy to maintain constant sales is an essential objective of the business. This can be made possible only if the firm is able to assess the short term demand, as well as long term demand of its products.

4. Formulating suitable sales strategy in accordance with the changing pattern of demand is essential and this can be done only with the help of demand forecasting.

5. Forecasting financial requirements of the firm could be made possible only with the help of demand forecasting data.

2. Objectives of long-term forecasting

1. Demand forecasting is very essential for long-term activities of the firm. The firm can plan effectively a new project, or expand or modernize the existing project. It may also diversify the product. These may require either technological change or upgradation of technology. For long term business planning, long-term forecasting has to be done.

2. Assessing long-term financial needs, i.e., financial planning will be possible and also effective only with the assessment of long term forecasting of demand.

3. Finally, man-power planning depends on the expansion or contraction of the business in the long run. For this purpose long-term demand forecasting is essential; as a business firm exists mainly for producing and selling of commodities and services.

Approach to forecast

Approach to Forecasting
Approach to Forecasting

There is no simple formula which enables an individual firm or a business unit to predict the future with certainty. Nobody can predict non-economic factors like natural disaster or political upheavals or military coup — all of which have important influence on demand for a product.

Better forecasting can be done only by understanding the principle governing economic activity and of the inter-relationships between economic variables.

There are two dangers to be guarded against in approaching forecasting:

1. Forecasting by Mathematical Approach

We may be blinded by a mathematical formula. The fact that the sales in the past had been influenced by a dozen variables formulated into an equation may not hold good for the future also. We may be led to believe that this precise formula represents an eternal truth. It is not so. It is rather unsafe to depend too heavily on the continuity of history.

Mathematical and statistical techniques are essential in clarifying relationships and providing techniques of analysis, but ultimately they are not substitute for judgement.

2. Forecasting by Judgement

Secondly, the role of judgement in business should be properly understood. In fact, judgement is one of the basic requirements for good forecasting, the other two being information and analysis. Judgement means correctly interpreting information, carefully selecting an appropriate forecasting technique and evaluating the forecast made. Learning from experience is an important part of good judgement.

In forecasting, generally, we predict the future with the help of the past through mathematics, statistics and judgement. Balancing the various factors and combining them judiciously with judgement is important. There should be a common sense mean between pure guessing and too much of mathematics.

Forecasting is like trying to drive a car blind-folded and following directions given by a person who is looking out of the back window.

3. Scientific Approach to Forecast

In order to have scientific approach to forecasting, the following points should be borne in mind.

1. Identify and clearly state the objectives of forecasting problem — whether it is for long-term or short-term; whether it is for market-share or for industry as a whole.

2. Select appropriate method of forecasting. The method depends upon the purpose or objectives of the demand forecast, the nature of the product, etc.

3. Identify the variables affecting the demand for the product and express them in appropriate form.

4. Gather relevant data to represent the variables.

5. Make-use of statistical techniques to determine the most probable relationship between dependent and the independent variable.

6. Prepare the forecast and interpret the results. This is more important to the management, as it is interested only in the interpretation of the result for framing the appropriate policy.

7. Once a product forecast for the whole industry is available, it is easy for the firm to estimate its share of the market.

8. In preparing company forecasts, the management may rely on two assumptions:

  1. The ratio of company sales to total industry sales will continue as in the past; or
  2. The ratio of company sales to total industry sales will change.

Forecasting should be a continuing activity.