Demand theory objectives
(1) Forecasting sales,
(2) Manipulating demand,
(3) Appraising salesmen’s performance for setting their sales quotas, and
(4) Watching the trend of the company’s competitive position.
Of these the first two are most important and the last two are ancillary to the main economic problem of planning for profit.
- Forecasting Demand:
Forecasting refers to predicting the future level of sales on the basis of current and past trends. This is perhaps the most important use of demand studies. True, sales forecast is the foundation for planning all phases of the company’s operations. Therefore, purchasing and capital budget (expenditure) programmes are all based on the sales forecast.
- Manipulating Demand:
Sales forecasting is most passive. Very few companies take full advantage of it as a technique for formulating business plans and policies. However, “management must recognize the degree to which sales are a result only of the external economic environment but also of the action of the company itself.
Sales volumes do differ, “depending upon how much money is spent on advertising, what price policy is adopted, what product improvements are made, how accurately salesmen and sales efforts are matched with potential sales in the various territories, and so forth”.
Often advertising is intended to change consumer tastes in a manner favourable to the advertiser’s product. The efforts of so-called ‘hidden persuaders’ are directed to manipulate people’s ‘true’ wants. Thus sales forecasts should be used for estimating the consequences of other plans for adjusting prices, promotion and/or products.
Importance of Demand Analysis:
A business manager must have a background knowledge of demand because all other business decisions are largely based on it. For example, the amount of money to be spent on advertising and sales promotion, the number of sales-persons to be hired (or employed), the optimum size of the plant to be set up, and a host of other strategic business decisions largely depend on the level of demand.
Why should a business firm invest time, effort and money to produce colour TV sets in a poor country like Chad or Burma, unless there is sufficient demand for it? A firm must be able to describe the factors that cause households, governments or business firms to desire a particular product like a typewriter. It is in this context that an understanding of the theory of demand is really helpful to the practicing manager.
Demand theory is undoubtedly one of the manager’s essential tools in business planning both short run and long run. The objective of corporate planning is to identify new areas of investment.
In a dynamic world characterised by changes in tastes and preferences of buyers, technological change, migration of people from rural to urban areas, and so on, it is of paramount importance for the business manager to take into account prospective growth of demand in various market areas before taking any decision on new plant location (i.e., the place of birth decision of a business firm).
If demand is expected to be stable, big sized plant may have to be set up. However, if demand is expected to fluctuate, flexible plants (possibly with lower average costs at the most likely rate of output) may be desirable.
A huge amount of capital may be required to carry inventories of finished goods. If demand is really responsive to advertising, there may be a strong rationale for heavy outlay on market development and sales promotion.
Demand considerations may directly and indirectly affect day-to-day financial, production and marketing decisions of the firm. Demand (sales) forecasts do provide some basis for projecting cash flows and net incomes periodically. Moreover, expectations regarding the demand for a product do affect production scheduling and inventory planning.
Again a business firm must take into account the probable reactions of rivals and buyers — actual and potential — before introducing changes in prices, advertising or product design. Therefore, for all these reasons, business managers can and should make good use of the various concepts and techniques of demand theory.