Forecasting of demand is the art of predicting demand for a product or a service at some future date on the basis of certain present and past behaviour patterns of some related events. Please remember that forecasting is no simple guessing but it refers to estimating scientifically and objectively on the basis of certain facts and events relevant to the art of forecasting.
Usefulness
Forecasting of demand plays a vital role in the process of planning and decision-making whether at the national level or at the level of a firm. The importance of demand of forecasting has increased all the more on account of mass production and production in response to demand. No useful business planning can be done without proper estimates of demand forecast.
Scope of Forecasting
Forecasting can be at the international level depending upon the area of operation of given economic institution. It can also be confined to a given product or service supplied by a small firm in local area. The scope of work will depend upon the area of operation in the present and proposed in future. Much would depend upon the cost and time involved in relation to the benefit of the information acquired through the study of demand. The necessary trade-off has to be struck between the cost of forecasting and the benefits flowing from such forecasting.
Determinants of Demand
Various goods can be divided into consumber goods and producer goods. Consumer goods can be defined as those which are used for final consumption. Examples of consumer goods are ready-made garments, TV, residential houses etc. Consumer goods may be further subdivided into durable consumer goods and non-durable consumer goods. Durable consumer goods are those which can be consumed more than once over a period of time e.g. a car, a refrigerator, a ready-made shirt, an umbrella and an electric bulb. Non-durable consumer goods are those which cannot be consumed more than once, for example, sweets, bread, milk, etc.
Producer goods are those which are used for the production of other goods either consumer goods or producer goods themselves. Examples of such goods are machines, tools, implements etc.
Factors affecting demand for non-durable consumer goods
There are three basic factors which influence the demand for these goods:
(i) Disposable income: Other things being equal, the demand for a commodity depends upon the disposable income of the household. Disposable income is found out by deducting personal taxes from the personal income.
(ii) Price: Other things being equal, the demand for a commodity depends upon its own price and the prices of the related goods (its substitutes and complements). While the demand for a good is inversely related to its own price and the price of its complements, it is positively related to the price of its substitues.
(iii) Demography: This involves the characteristics of the populaton, human as well as non-human, using the product concerned.
Factors affecting the demand for durable-consumer goods
(i) Whether a consumer will go on using the good for a long time or will he replace it depends upon factors like his social status, prestige, level of money income, the rate of obsolescence ete.
(ii) These goods require special facilitites for their use e.g. roads for automobilies, and electricity for refrigerators and T.Vs. The existence and growth of such factors in an important variable.
(iii) As consumer durables are used by more than one person, the decision to purchase may be influence by family charactersitics like size, age distribution and sex comosition.
(iv) Demand for consumer durables is very much influenced by their prices and credit facilities available to buy them.
Factors affecting the demand for producer goods
Since producers goods or capital goods help in further production, the demand for them is derived from the demand of consumer goods they produce. The demand for them depends upon the rate of profitability of user industry, level of wage rates and size of the market of the user industries. Hence data required for estimating demand for producer goods (capital goods) are:
(i) growth prospects of the user industries;
(ii) norms of consumption of capital goods per unit of installed capacity.
Methods of forecasting
There is no easy method or simple formula which enables an individual or a business to predict the future with certainty or to escape the hard process of thinking. The firm has to apply to proper mix of judgment and scientific formulae in order to correctly predeict the future demand for a producte. The following are commonly available techniques of demand forecasting:
(i) Survey of Buyers’ Intentions: The most direct method of estimating demand in the short run is to ask customers what they are planning to buy for the forthcoming time period usually a year. Thus in this method the burden of forecasting is put on the customers. However, it would not be wise to depend wholly on the buyers’ estimates and they should be used cautiously in the light of the seller’s own judgement. A number of biases may creep into the surveys. The customers may themselves misjudge their requirements or may mislead the surveyors. The method is useful when bulk of sale is made to industrial producers who generally have firm future plans.
(ii) Collective opinion method: In this method, salesmen are required to estimate expected sales in their respective territories. The rationale of this method is that salesmen being closest to the customer are likely to have the most intimate feel of the market. These estimates of salesmen are consolidated to find out the total estimated sales. These estimates are reviewed to eliminate the bias of optimism on the part of some salesmen and pessimism on the part of others. These revised estimates are further examined in the light of factors like proposed change in selling prices, product designs and advertisement programmes, expected changes in competition. The final sales forecast would emerge after these factors have been taken into account.
Although this method is simple and is based on first hand information of those who are directly connected with sales but this method is subjective as personal opinions can possibly influence the forecast.
(iii) Expert Opinion method: In this method instead of depending upon the opinions of buyers and salesmen, firms can obtain views of the specialists or experts in their respective fields. Opinions of different experts are sought and their identity is kept secret. These opinions are then exchanged among the various experts and their reactions are sought and analysed. The process goes on until some sort of unanimity is arrived at among all the experts. This method is best suited in circumstances where intractable changes are occurring.
(iv) Statistical methods: Statistical method have proved to be very useful in forecasting demand. The important statistical methods of demand forecasting are:
Trend Projection method: A firm which has been in existence for some time, will such data when arranged chronologically yield ‘time series’. The time series relating to state represent the past pattern of effective demand for a particular product. Such data can be used to project the trend of the time series. This can be done either through graph or through least squae method.
Graphical Method: A trend line can be fitted throught a series graphically. Old values of sales of different areas are plotted on a graph and a free hand curve is drawn passing throught as many points as possible. The direction of this free hand curve shows the trend. The main drawback of this method is that it may show the trend but not measure it.
Least Square Method: The least square method is based on the assumption that the past rate of change of the variable under study will continue in the future. It is a mathematical procedure for fitting a line to a set of observed data points in such a manner that the sum of the squared differences between the calculated and observed value is minimised. This technique is used to find a trend line which best fit the available data. This trend is then used to project dependant variable in the future. This method is very popular because it is simple and in expensive.
Controlled Experiments: Under this method, an effort is made to vary separately certain determinants of demand which can be manipulated, for example price, advertising, etc., and conduct the experiments assuming that the other factors remain constant. This, the effect of demand determinants like price, advertisement, packaging, etc., on sales can be assessed by either varying them over different markets or by varying them over different time periods in the same market.
It should be noted however, that the market division here must be homogeneous with regard to income, tastes, etc. The method of controlled experiments is used relatively less because this method of demand forecasting is expensive as well as time consuming. Moreover, controlled experiments are risky too because they may lead to unfavourable reactions from consumers and competitors. It is also difficult to determine what conditions should be taken as constant and what factors should be regarded as variable so as to segregate and measure their influene on demand. Besides, it is difficult to satisfy the condition of homogeneity of markets.
Study of general economic environment: The various methods suggested till now are related with product concerned. These methods are based on past experiene—trying to project the past into the future. Such projection is not effective where they are economic ups and downs. Particularly, the projection of trend cannot indicate the turning point from slump to recovery or from boom to recession. Therefore, in order to find out these turning points it is necessary to find out the general behaviour of the economy. For this purpose, an eye should be kept on certain indicators; there are certain lead indicators and there are other which appear after a lag. It is necessary to understand the behaviour of various indicators in order to form in idea about the likely economic environment in the near future.
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