NPD Practices

NEW PRODUCT FORECASTING

Part III: Translating Penetration Estimates into Long Run Sales
by Jeffrey Morrison, Director of Modeling Hquifax Corporation (jeffmorrison@equifax.comj
orecastcrs have always struggled with how best to develop realistic projections in an environment where historical data and adequate market research may be scarce. Although new product forecasters are faced with even more challenges in this area, some statistical modeling techniques used to analyze mature products can be applied to new products to provide valuable insight into long run market acceptance. This is the last article in a three part series discussing quantitative forecasting techniques for new product forecasting. In the last article (Visions, October 1999; page 1:{), we looked at Jim who had recently been promoted to Product Manager in a national sports eqUipment company, ABC Athletics. The research group had just completed the development of a new golf ball that travels 2()<)'{) further than anything on the market. The financial people needed a ten-year forecast for demand and revenue. One of Jim's main tasks in his new job was to develop a sales forecast that he could sell as "believable" to the very conservative vicepresident of Finance. By using some reIativelystraightforward regression techniques and information from a survey, ,Jim was able to develop a variety of "what-if' scenarios related to the anticipated long run market penetration for the new product. Now Jim's task is to translate those long run penetration estimates into unit sales over time.

municated through certain channels over time among the members of a social system." Another pioneer in this field, Frank Bass (19(l9). describes the diffusion process as a result of two independent drivers: mass media and word of mouth. The mass media influence covers those consumers interested in the "latest and greatest" aspect.'l of product.,> and services. This market segment's purchase decision is theorized to be externally derived - specifically from media advertisements that generate awareness. On the other hand, the word of mouth influence is theorized to be much greater - reflecting the internal communi-

ture, these coefficients are simply referred to as p (mass media) & q (word of mouth). If he had not been able to find data on a similar product, Jim would have had to usc some industry values for p & q referred to in the Bass literature. Table 1 shows the older product's historical unit sales for the last 10 years. Notice from columns A & B that it is a fully mature product - completing all phases of the product life cycle: Introduction, Growth, Maturity, and Decline. Specifically, the saturation level occurs at year 6 with annual sales of 1,710 units. By year 10, new sales were about zero and the prod-

Table 1: AnTlual Sales of a Similar Product (Actllals)

A AetuaJ Non Cumulative Sales Year) Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 150 400 1,225 1,675 1,700 1,710 1,650 800 50 1

B
Actual Cumulative Sales 150 550 1,775 3,450 5,150 6,860 8,510 9,310 9,360 9,361

C Cumulative Sales ILag 1 Year I 0 150 550 1,775 3,450 5,150 6,860 8,510 9,310 9,360

0
Square of Cumulative Sales ILag 1 Yearl 0 22,500 302,500 3,150,625 11,902,500 26,522,500 47,059,600 72,420,100 86,67(l,100 87,609,600

INTRODUCTION TO DIFFUSION ANALYSIS

Substantial literature exists on the dynamics of new product innovations. These dynamics often refer to the rate of new product acceptance into the market as it.'> diffusion. Although no single diffusion framework provides all the answers, Rogers (1962) was one of the earlier pioneers describing new product diffusion as a five stage process: Awareness Interest Evaluation Trial Adoption In general, Rogers saw diffusion as the process by which an innovation "is com-

cation dynamics among consumers. When placed in a mathematical framework, the Bass theory provides one of several forecasting solutions for new product diffusion.

THE BASS MODEL

In the last article, Jim was able to derive a market penetration rate of 43% from the survey data, given the average price of the product and demographics of the target market. Well, today is ,Jim's lucky day. He just uncovered historical sales data on an older product which he thinks might mimic the life cycle of his new product. Jim decides to use the Bass model to estimate the two components of new product diffusion: the coefficient of innovation and the coefficient of imitation. In the Iitera-

uct line was soon discontinued. Now that we have some historical data from a similar product, we are ready to estimate p & qwithin the Bass framework using linear regression. The dependent variable is specified as Column A in '1able 1 - actual Non-Cumulative Unit Sales. The explanatory variables are simply transforms of the history - lagged one period. The first of these variables is shown in Column C - Cumulative Unit Sales (Lagged 1 year). The second variable (Column D) is the square of the first variable. That's it! All Jim has to do now is simply run the regression. Now we use the regression coefficient.'l (lable 2) to calculate p & q and compute the Bass predictions for the similar product:

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Step 1: Step 2: Step 3:

Table 2: Regmssion RcsuUs:

FORECASTING NEW PRODUCT SALES WITH THE BASS MODEL:

Now ,Jim is ready to forecast unit sales for his new product. With the coefficient of innovation (0.047261) and the coefficient of imitation (0.188441) from the similar product, he simply has to make a guess at the total lifetime sales for his new product. If the potential industry sales over the next 10 years is 10,000,000 golf balls and the survey indicates the new product will attain about a 43% penetration, the lifetime expected sales would be 4,300,000. The forecast equation is the same as before, but with different a value for lifetime sales: For example, for the first period forecast, non-cumulative unit sales are: Bass Forecast Equation for Non-Cumulative Unit Sales I = I = 0.047261 *(4,300,000-0) + 0.738441 * (0/4,300,000) * (4,300,000-0) = 203,222
Table 4: New Pmduct Forccast (Non-Cumulative Unit Sales)

Non-Cumulative Unit Sales= 442.41 + .691 *X1 -.0000782 *X2 R Square Number of Observations 0.901305673 10 Coefficients Intercept Xl Variable (Column C -Thble1) X2 Variable (Column 0 -Thble1) 442.4115 0.691179 -.0000782

Identify lifetime unit sales ('rable 1 col. B) Calculate p = Intercept / lifetime unit sales Calculate q = p + coefficient of Xl

= 9,361 = 0.047261 = 0.738441

t

Bass Forecast Equation of Non-Cumulative Unit Sales p * (lifetime sales - cumulative sales (L-l) ) + q * ( cumulative sales (L.I/ lifetime sales) * ( lifetime sales- cumulative sales (t-II )

As shown in 'Iable 3, the Year 1 Non-Cumulative Sales equal the intercept (442). The second period fitted value, then, would be calculated as follows: Non-Cumulative Unit Sales t = 2 = 0.047261 *(9,361-442) + 0.738441 * (442/9,361) * (9,361-442) = 733 How well did the model do in fitting the historical sales for the similar product? As seen in Table 3 and Figure 1, fitted sales are indeed close.
Figure 1: Fitted
Ir.'i.

Year 1 203,222 Year 6 816,846

Year 2 336,593 Year 7 508,584

Year 3 526,290 Year 8 200,892

Year 4
744,907 Year 9 54,876

Year 5 891,722 Year 10 12,580

ADDITIONAL FORECASTING SOLUTIONS:

Although the Bass Model has shown some very encouraging results in the past, it is dependent on a number of assumptions such as: Market potential of the new product remains consistent over time. Diffusion of an innovation is independent of all other innovations and is binary. Nature of innovation does not change over time. There are no supply restrictions. Product and market characteristics do not influence diffusion patterns. And although easy to compute, the model's simplicity is a 2-edged sword. For example ... How do we make adjustments to the forecast if our marketing plan is significantly different than others in the past? How do we account for known pent-up demand (pre-seiling) in the forecast? How can we input assumptions as to the symmetry of the product life cycle? Can we revise the forecast based upon latest market conditions and purchases? What about competition? Fortunately, additional techniques are available that focus on the S-shaped pattern of the pl'oduct life cycle. Some are based on various formulations of the Logistic and
Continued on page 41

Actual Unit Sales

NonCumulative Unit Sales

2,500 . . . . . . - Predicted 2,000 1,500 1,000 500 0
Aetuals

p-

r-

2
3 4 567

, _ _ _ _ _ _ _ _ _Years Since ProdUCtL"1l1TIch _ __

10
..J

Table 3: Annual Golf Ball Sales a Similar Pmduct (Fitted)

A Actual Non Cumulative Sales Year Year Year Year Year Year Year Year Year Year 1 2 3 4 5 6 7 8 9 10 150 400 1,225 1,675 1,700 1,710 1,650 800 50 1

B Fitted Non Cumulative Sales 442 733 1,146 1,622 1,941 1,778 1,107 437 119 27

C Actual Cumulative Sales 150 550 1,775 3,450 5,150 6,860 8,510 9,310 9,360 9,361

D
Fitted Cumulative Sales 442 1,175 2,321 3,943 5,884 7,662 8,769 9,207 9,326 9,353

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PDMA VISIONS APRIL 2000 VOL. XXIV NO.2

PDMA CONFERENCE REVIEW

Continucd from pagc J4

the workshop is that a business needs to look at mUltiple analyses of a portfolio prior to making critical project prioritization decisions. Looking at only one analysis can yield misleading results. The second workshop, conducted by Rich Moore, President and CEO of Integrated Development Enterprise, Inc. (IDe),

a software solution provider, was entitled "Hands-On IT-Enabled Portfolio Management." It discussed how new web-enabled product-development applications are finally giving management the right tools to manage and accelerate the portfolio on an enterprise-wide basis. This workshop clarified and defined the role of IT in port-

folio management and gave participants a vision of how portfolios will be managed in the new millennium. The learnings participants took back to their organizations from the conference can be applied immediately making this an extremely valuable event for all PDMA members.

MANAGED INNOVATION?
Continued from pagc 26

rative and regulated process, such as the Lead User System, has been adopted at 3M quite smoothly. 3M's on-going measurement and value assessment process finds that even the most productive "traditional method" inventors (those prestigious aM scientists whose reputations were built by using the traditional, "inventor in the lab" method of innovation) credit the Lead User System with enriching their own pursuit of innovation. These scientists, and other members of the 3M Lead User teams, have developed a more grounded appreciation of the fact that novel concepts are often found, and will continue to be found, in the interactions that take them out of the lab, out of the com-

pany and even out of their industries. From "shadowing" a third world user to understand where their process strengths and weaknesses exist, to working with professional theatrical mask makers to better understand human skin properties, the

Lead User System provides a proven discipline for profitably leveraging resourees inside and outside of 3M for models, expertise and future competitive advantages.

2000 ASI Associates

Anyone interested in more information about this issue may find the following resourees interesting: Von Hippel, Eric Sources of Innovation, Oxford University Press, 1994 Lead User Concepts web site at http://www/leaduser.com "Creating Breakthroughs at 3M", by EI'ic von Hippel, Stefan Thomke and Mary Sonnack, Harvard Business Review, September-October 1999. pp. 47-57

NEW PRODUCT FORECASTING

Continued from page 80

Gompertz curves - diffusion frameworks allowing a more detailed extraction of key components of the process. For example, it would be advantageous to input assumptions about the product's half-life, life cycle symmetry, pent-up demand, and the most recent unit sales in forecasting futurc demand. Since these key components are specified in the model structure, the ana-

Iyst would have the flexibility to change their assumptions to better integrate marketing plans into the forecast. The mathematics of these routines can be programmed in SAS, Fortran, C++, or Visual Basic. However, some packages like LifeCast Pro are designed with excellent GlJI interfaces for use by product managers, financial analysts, and business forecasters.

References: (1). NEW PRODUCT DIFFUSION MODb'LS INMARKEJ'ING: A REVJb'WAND DIRRCTJON FOR RESEARCH. by Vijay Mahajan, Eitan Muller, and Frank M. Bass. Journal of Marketing. Vol. 54 (January 1990), pp 1-26. (2). NEW PRODUCT DEVELOPMENT: MANAGING AND FORECASl1NG FOR STRATEGIC SUCCESS. By Robert J. Thomas, John Wiley & Sons (1998). pp 189-195.

If you would like an Excel spreadsheet of the Bass Model, please contact Jeff Morrison at jeff.morrison@equifax.com

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