DEMAND FORECASTING & METHODS
By: Debbrata Hazra Ankit Saxena Gaurav Mishra Chinmaya Mohanty
Contents
Demand Forecasting Features
Managerial Uses
Levels of Forecasting Criteria of a Good Demand Forecasting Methods and Illustrations Conclusion
Demand Forecasting
Demand Forecasting refers to an estimation of most likely future demand for a product under given conditions.
Features of Demand Forecasting
It is basically a guess work but it is an educated and well thought out guesswork. It is in terms of specific quantities. It is undertaken in an uncertain atmosphere. A forecast is made for a specific period of time which would be sufficient to take a decision and put it into action. It is based on historical information and the past data. It tells us only the approximate demand for a product in the future. It is based on certain assumptions. It cannot be 100% precise as it deals with future expected demand
Managerial Uses Of Demand Forecasting
Short Run Long Run
Production planning Sales forecasting Estimates short run financial requirements Reduce the dependence on chances
Business Planning Manpower Planning Financial Planning Business Control Determination of the growth rate of the firm
Frame realistic pricing policy
Levels of Demand Forecasting
Micro Level Industry Level Macro Level
Criteria of Good Demand Forecasting
Equity Plausibility Simplicity Durability Flexibility Availability of Data Economy Quickness
Methods of Demand Forecasting
Survey Methods:
1. 2. 3. 4. 5. Consumers Interview Method Direct Interview Method Jury of Executive Method Delphi Method Output Method
Statistical Methods:
1. Trend Projection Methods 2. Economic Indicators
SURVEY METHODS
Consumers Interview Method
Under this method, efforts are made to collect the relevant information directly from the consumers with regard to their future purchase plans.
Direct Interview Method
Under this method Customers are directly contacted and interviewed. Direct and simple questions are asked to them.
Jury of Executive Method
Rationale:
Upper-level management has best information on latest product developments and future product launches.
Approach:
Small group of upper-level managers collectively develop forecasts Opinion of Group.
Typical Applications:
Short-term and medium-term demand forecasting.
Jury of Executive Method
Main Advantages:
1. Combine knowledge and expertise from various functional areas. 2. People who have best information on future developments generate the forecasts.
Main Drawbacks:
1. 2. 3. 4. 5. Expensive. No individual responsibility for forecast quality. Risk that few people dominate the group. Subjective. Reliability is questionable.
Delphi Method
Rationale
Eliciting the opinions of a group of experts with the help of mail survey. Anonymous written responses encourage honesty and avoid that a group of experts are dominated by only a few members.
Delphi Method (Approach)
Coordinator Sends Initial Questionnaire Each expert writes response (anonymous) Coordinator performs analysis
Coordinator sends updated questionnaire
No
Consensus reached?
Yes
Coordinator summarizes forecast
15
Delphi Method (Contd.)
Main Advantages:
1. Generate consensus. 2. Can forecast long-term trend without availability of historical data.
Main Drawbacks:
1. Slow process. 2. Experts are not accountable for their responses. 3. Little evidence that reliable long-term forecasts can be generated with Delphi or other methods.
16
Output Method
This method forecasts the demand based on the consumption coefficient of the various uses of the product. Suitable for estimating demand for intermediate products. Also called as consumption coefficient method.
Steps: 1. Identify the possible uses of the products. 2. Define the consumption coefficient of the product for various uses. 3. Project the output levels for the consuming industries. 4. Derive the demand for the project.
STATISTICAL METHODS
Trend Projection Methods
Secular or Long Run Movements Seasonal Movements Cyclical Movements Random Movements
Trend Projection Methods (Contd.)
Advantages: It uses all observations. The straight line is derived by statistical procedure. A measure of goodness fit is available.
Disadvantages:
More complicated. The results are valid only when certain conditions are satisfied.
Linear Trend Line
y = a + bx
where a = intercept of the relationship b = slope of the line x = time period y = forecast for demand for period x xy - nxy b = x2 - nx2 a = y-bx
where n = number of periods x x = = mean of the x values n y y = n = mean of the y values
12-21
21
Least Squares Example
x(PERIOD) 1 2 3 4 5 6 7 8 9 10 11 12 78 y(DEMAND) 73 40 41 37 45 50 43 47 56 52 55 54 557 xy 73 80 123 148 225 300 301 376 504 520 605 648 3867 x2 1 4 9 16 25 36 49 64 81 100 121 144 650
12-22
22
Least Squares Example (Contd.)
78 x = = 6.5 12 557 y = = 46.42 12 xy - nxy b = = 2 - nx2 x
3867 - (12)(6.5)(46.42) =1.72 2 650 - 12(6.5)
a = y - bx = 46.42 - (1.72)(6.5) = 35.2
12-23
23
Linear trend line y = 35.2 + 1.72x Forecast for period 13 y = 35.2 + 1.72(13)
70 60 50 Demand
= 57.56 units
Actual
40
Linear trend line 30 20 10 0 | 1 | 2 | 3 | 4 | 5 | | 6 7 Period | 8 | 9 | 10 | 11 | 12 | 13
12-24
24
Moving Average
Naive forecast
Demand in current period is used as next periods forecast.
Simple moving average
Uses average demand for a fixed sequence of periods. Stable demand with no pronounced behavioral patterns.
Weighted moving average
Weights are assigned to most recent data.
12-25
25
Moving Average: Nave Approach
ORDERS MONTH PER MONTH Jan Feb Mar Apr May June July Aug Sept Oct Nov 120 90 100 75 110 50 75 130 110 90 FORECAST 120 90 100 75 110 50 75 130 110 90
12-26
26
Simple Moving Average
n
Di i=1
MAn =
where n = number of periods in the moving average Di = demand in period i
12-27
27
3-Month Simple Moving Average
MONTH Jan Feb Mar Apr May June July Aug Sept Oct Nov ORDERS PER MONTH 120 90 100 75 110 50 75 130 110 90 MOVING AVERAGE 103.3 88.3 95.0 78.3 78.3 85.0 105.0 110.0
Di i=1
MA3 = 3 =
90 + 110 + 130 3
= 110 orders for Nov
12-28
28
5-Month Simple Moving Average
MONTH Jan Feb Mar Apr May June July Aug Sept Oct Nov ORDERS PER MONTH 120 90 100 75 110 50 75 130 110 90 MOVING AVERAGE 99.0 85.0 82.0 88.0 95.0 91.0
Di i=1
MA5 =
5
90 + 110 + 130+75+50 5
= 91 orders for Nov
12-29
29
Smoothing Effects
150 5-month 125 100 Orders
75
50 Actual 25 0 | Jan | Feb | Mar | | Apr May | | June July Month | Aug | Sept | Oct | Nov 3-month
12-30
30
Weighted Moving Average
Adjusts moving average method to more closely reflect data fluctuations
WMAn =
where
i=1
Wi Di
n
Wi = the weight for period i,
between 0 and 100 percent
Wi = 1.00
12-31
31
Weighted Moving Average (Example)
MONTH
August September October
WEIGHT
17% 33% 50%
DATA
130 110 90
3
November Forecast
WMA3 =
Wi Di i=1
= (0.50)(90) + (0.33)(110) + (0.17)(130) = 103.4 orders
12-32
32
Chain Ratio Method
Market Potential for heated coats in the US:
Population (U) = 280,000,000 Proportion of U that are age over 16 (A) = 75% Proportion of A that are men (M) = 50% Proportion of M that have incomes over $65k (I) = 50% Proportion of I that live in cold states (C) = 50% Proportion of C that ski regularly (S) = 10% Proportion of S that are fashion conscious (F) = 30% Proportion of F that are early adopters (E) = 10% Average number of ski coats purchased per year (Y) = .5 coats Average price per coat (P) = $ 200
33
Chain Ratio Method
Market Potential for heated coats in the US:
Market Sales Potential = UxAx M xI x C xS x F xE xY = 280 Million x 0.75 x 0.50 x 0.50 x 0.50 x 0.10 x 0.30 x 0.10 x200 = $7.88 Million
34
Econometric Method
An advanced forecasting tool, it is a mathematical expression of economic relationships derived from economic theory. Economic variables incorporated in the model.
1. Single Equation Model: Dt = a0 + a1 Pt + a2 Nt
Where,
Dt = demand for a certain product in year t. Pt = price of the product in year t. Nt = income in year t.
35
Econometric Method
2. Simultaneous equation method: GNPt = Gt + It + Ct It = a0 + a1 GNPt Ct = b0 + b1 GNPt Where, GNPt = gross national product for year t.
Gt = Governmental purchase for year t. It = Gross investment for year t.
Ct= Consumption for year t.
36
Econometric Method
Advantages: The process sharpens the understanding of complex cause effect relationships. This method provides basis for testing assumptions.
Disadvantages: It is expensive and data demanding. To forecast the behaviour of dependant variable, one needs the projected values of independent variables.
37
Uncertainties In Demand Forecasting
Data about past and present markets:
Lack of standardization:- product, price, quantity, cost, income. Few observations Influence of abnormal factors:- war, natural calamity
Methods of forecasting:
Inability to handle unquantifiable factors Unrealistic assumptions Excessive data requirement
38
Uncertainties In Demand Forecasting
Environmental changes:
Technological changes Shift in government policy Developments on the international scene Discovery of new source of raw material Vagaries of monsoon
39
40
Conclusion
Forecasting has taken an essential part of our life also.
