IV.

DEMAND FORECASTING
Source: Geetika, Salvatore

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 Meaning
• A tool to scientifically predict the likely
demand for a product for a particular
period of time in future
Categorization can be:
• By level of forecasting - firm, industry, and
economy(macro) level
• By time period- short and long term
• By nature of goods
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 Demand Forecasting
• To get an overview of the market and act
proactively
• To adjust production and avoid over
production and under production
• Essential for production scheduling,
purchase of raw materials, arranging
finance and advertising

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Qualitative/ Subjective Methods
• Used for short term forecasts when data
are not available
• Also for supplementing quantitative
forecasts

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Qualitative/ Subjective Methods
1. Consumers’ Opinion Surveys
2. Sales Force Composite Method
3. Expert Opinion- Group discussion and
Delphi methods
4. Market Simulation
5. Test Marketing

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Qualitative/ Subjective Methods
• Surveys on economic intentions can
reveal and can be used to forecast future
purchase of capital equipment, inventory
changes and major consumer
expenditures
• Complete enumeration (census) vs
sample
• Questionnaire, interview

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Qualitative/ Subjective Methods
Buying Intentions of consumers has limited use
because
- Consumer may not be able to clearly foresee the
choice,
- Wishful thinking
-Answers tailored to impress interviewer
- New alternatives may emerge,
-Passive because it does not measure variables
which are under management control
-Intention may not translate into actual buying
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Qualitative/ Subjective Methods
Sales Force Survey- Easy, cost effective,
reliable, ideal for short term forecasts
But
May be biases
Sales force may not have knowledge of
macro factors

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Qualitative/ Subjective Methods
Expert Opinion Method:
Group Discussion- Market consultants,
industry analysts with knowledge of
product and the market conditions
- Personal insights can be subjective
- To avoid the problem of dominant
personality, Delphi method

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Qualitative/ Subjective Methods
Delphi method: Developed by Rand Corporation in
1940s- arriving at consensus
- Anonymity
-Wide expertise
-Effective when there is no urgency
but
-Difficulty in getting panelists
-Requires understanding, skill and knowledge for
conceptualising, stimulating discussion and
making inferences by researcher .
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 Qualitative/ Subjective Methods
Market Simulation
- Controlled lab experiments where
consumer is given an amount and
expenditure behaviour is observed
- Aware of being observed, consumer may
not behave naturally
- Time consuming
- Costly
- Not large enough to generalise
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Qualitative/ Subjective Methods
Test Marketing: Changes are introduced
and Product is actually sold in select
markets and consumer response studied
• Most reliable qualitative method
• Highly suitable for new products
• Gives time for producer to make
necessary changes, if necessary
• Costly errors are avoided
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Qualitative/ Subjective Methods
• But very costly as it requires actual
production of the product
• Time consuming
• May be difficult to extrapolate in a large
country like India with heterogeneous
population

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 QUANTITATIVE METHODS

1. Time Series Method- Naïve forecasting

Variables change with time
Sources of variation in Time series :
 Secular Trend
 Seasonal Changes
 Cyclical Fluctuations
 Random or irregular fluctuations
Total variation , say in sales, is the result of all four
factors operating together. 14
 Time Series Method
• Trend Projection
• Simplest- projecting the past trend by
fitting a straight line to the data either
visually or more precisely through
regression

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 Least Squares Method
Least Squares Method- Most widely used time
series method
Linear Equation of a straight line is
Y = a + bX
where Y is the demand and X is the time period
(no of years), a and b are constants depicting
intercept and slope of the line. Calculation of Y
for any value of X requires the values of a and b,
for which 2 normal equations are prepared:

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 Least Squares Method

ΣY = na + b ΣX
ΣXY=a ΣX + b ΣX2
With values of a and b, straight line equation
is obtained and forecast is made for Y for
given value of X.

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 Time Series Method
Smoothing Techniques:
These predict values of a time series on the basis
of some average of its past values.
Useful when time series exhibit little trend or
seasonal variations but a great deal of irregular
or random variations

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 Time Series Method
Moving Average Method:
In this method, 3 (or 5) yearly / 3(or 5) monthly/ 3(or 5) day
moving averages of the required series is obtained. The
method is used in progression by ignoring the first entry
and incorporating the next one.
Average value of the last 3 (or 5) entries becomes the
forecast for the next period
The best forecast is chosen with the help of Root Mean
Square Error (RMSE).
RMSE is an Exponential smoothing method.
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 Time Series Method
• Simple moving average gives equal weight
to all observations, even though more
recent observations are likely to be more
important.
• Exponential smoothing overcomes this
problem.

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 Barometric Forecast
Barometric Forecast:
- When data indicates cyclical fluctuations, this
method alerts businesses to changes in overall
economic conditions
- To predict short term changes in economic
activity or turning points

- Barometric forecasting is done by NBER and

the Conference Board

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 Barometric Forecast
Related variables are categorised into 3
groups:
- Leading variables: Those that change
before the actual change
- Coincident Variables: Change along with
variable
- Lag variables: Follow the event
- If leading variables are identified, easy to
predict actual variables
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Barometric Forecast

PEAK

a ding
e
B. L

in ci dent
A.Co le
b
varia
C. Lagging
variable

Time
PEAK Trough

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 Barometric Forecast
Leading indicators :
• Building permits, new private housing units
• Number of loan applications
• New orders for durable goods for their
components and raw materials
• Index of consumer expectations
• Stock prices
• (Population growth for demand for schooling,
• Original purchase of durable goods for
replacement demand) 24
 Barometric Forecast
Coincident indicators :
• Rate of unemployment
• GDP
• Industrial production
• Manufacturing and trade sales

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 Barometric Forecast
• Lagging Indicators:
• Commercial and industrial loans
outstanding
• Change in consumer price index for
services

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 Barometric Forecast

Merits:
• Barometric forecasting is 80 to 90% successful
in forecasting turning points in economic activity.
• Method aligns macro with micro economics
• Less costly as it mostly depends on past data

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 Barometric Forecast
Problems:
• Can Only be used for short term forecasting
• It is not always possible to identify or get data on
a leading variable for the variable to be forecast
• Variability in lead time may be considerable
• The method cannot predict the magnitude of the
changes.;
Therefore, barometric forecasting should be used
in conjunction with other methods
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 Econometric Modelling for
Forecasting
• Identifying and measuring the relationship
• Can be single variable or multivariate regression
model
• Single equation models for a firm’s demand;
Large multiple equation models for the entire
economy
• Identify relevant determinants ( explanatory/
independent variables) of the variable to be
forecast
• Get data and fit to equation to get coefficients
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D= a0+ a1Y+ a2 Px+a3Py+a4A+ε
• Not subjective like the qualitative methods
• Based on causal relationships and
produces accurate results
• Method is consistent
• Forecasts both direction and magnitude of
change

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• Uses complex calculations
• Costly and time consuming

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 Problems in Demand
Forecasting
• Inadequate analysis of the market- include
all potential users of a product
• Unforeseen events
• Changing fashions and tastes
• Consumer Psychology
• Lack of expertise
• Lack of adequate data

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 Sums in Forecasting
Data for demand for watches for 5 years is
given, estimate demand for 2013:
Year 2004 2005 2006 2007 2008
No 120 130 150 140 160

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 Sum in Forecasting
Year X Y X2 Y2 XY
2004 1 120 1 14400 120
2005 2 130 4 16900 260
2006 3 150 9 22500 450
2007 4 140 16 19600 560
2008 5 160 25 25600 800
Total 15(ΣX) 700 55 99000 2190
n=5 (ΣY) (ΣX2 ) (ΣXY)
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 Sums in Forecasting
Normal equation: Y= a + bX (i)
ΣY= na + b ΣX (ii) ΣXY =aΣX + b ΣX2 (iii)
700= 5a + 15b (iv) 2190=15a + 55b(v)
Solving (iv) and (v) we get,
10 b= 90 b=9; Substituting the value of b in (iv)

700=5a+15* 9 5a=565 a=113

Y=113+9X. For year 2013, X will be 10.
Y 2013= 113 + 9 * 10
= 203 watches

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