According to Evan J. Douglas, “Demand estimation (forecasting) may be defined as a process of finding values for demand in future time periods.”
In the words of Cundiff and Still, “Demand forecasting is an estimate of sales during a specified future period based on proposed marketing plan and a set of particular uncontrollable and competitive forces.”
Demand forecasting enables an organization to take various business decisions, such as planning the production process, purchasing raw materials, managing funds, and deciding the price of the product. An organization can forecast demand by making own estimates called guess estimate or taking the help of specialized consultants or market research agencies.
Significance of Demand Forecasting
Demand plays a crucial role in the management of every business. It helps an organization to reduce risks involved in business activities and make important business decisions. Apart from this, demand forecasting provides an insight into the organization’s capital investment and expansion decisions.
The significance of demand forecasting is shown in the following points:
(i) Fulfilling objectives
Implies that every business unit starts with certain pre-decided objectives. Demand forecasting helps in fulfilling these objectives. An organization estimates the current demand for its products and services in the market and move forward to achieve the set goals.
For example, an organization has set a target of selling 50, 000 units of its products. In such a case, the organization would perform demand forecasting for its products. If the demand for the organization’s products is low, the organization would take corrective actions, so that the set objective can be achieved.
(ii) Preparing the budget
Plays a crucial role in making budget by estimating costs and expected revenues. For instance, an organization has forecasted that the demand for its product, which is priced at Rs. 10, would be 10, 00, 00 units. In such a case, the total expected revenue would be 10* 100000 = Rs. 10, 00, 000. In this way, demand forecasting enables organizations to prepare their budget.
(iii) Stabilizing employment and production
Helps an organization to control its production and recruitment activities. Producing according to the forecasted demand of products helps in avoiding the wastage of the resources of an organization. This further helps an organization to hire human resource according to requirement. For example, if an organization expects a rise in the demand for its products, it may opt for extra labor to fulfill the increased demand.
(iv) Expanding organizations
Implies that demand forecasting helps in deciding about the expansion of the business of the organization. If the expected demand for products is higher, then the organization may plan to expand further. On the other hand, if the demand for products is expected to fall, the organization may cut down the investment in the business.
(v) Taking Management Decisions
Helps in making critical decisions, such as deciding the plant capacity, determining the requirement of raw material, and ensuring the availability of labor and capital.
(vi) Evaluating Performance
Helps in making corrections. For example, if the demand for an organization’s products is less, it may take corrective actions and improve the level of demand by enhancing the quality of its products or spending more on advertisements.
(vii) Helping Government
Enables the government to coordinate import and export activities and plan international trade.
Objectives of Demand Forecasting
Demand forecasting constitutes an important part in making crucial business decisions.
The objectives of demand forecasting are divided into short and long-term objectives, which are shown in Figure-1:
- Short-term Objectives
Include the following:
(i) Formulating production policy
Helps in covering the gap between the demand and supply of the product. The demand forecasting helps in estimating the requirement of raw material in future, so that the regular supply of raw material can be maintained. It further helps in maximum utilization of resources as operations are planned according to forecasts. Similarly, human resource requirements are easily met with the help of demand forecasting.
(ii) Formulating Price Policy
Refers to one of the most important objectives of demand forecasting. An organization sets prices of its products according to their demand. For example, if an economy enters into depression or recession phase, the demand for products falls. In such a case, the organization sets low prices of its products.
(iii) Controlling Sales
Helps in setting sales targets, which act as a basis for evaluating sales performance. An organization make demand forecasts for different regions and fix sales targets for each region accordingly.
(iv) Arranging finance
Implies that the financial requirements of the enterprise are estimated with the help of demand forecasting. This helps in ensuring proper liquidity within the organization.
2. Long-term Objectives
Include the following
(i) Deciding the production capacity
Implies that with the help of demand forecasting, an organization can determine the size of the plant required for production. The size of the plant should conform to the sales requirement of the organization.
(ii) Planning long-term activities
Implies that demand forecasting helps in planning for long term. For example, if the forecasted demand for the organization’s products is high, then it may plan to invest in various expansion and development projects in the long term.
Factors Influencing Demand Forecasting:
Demand forecasting is a proactive process that helps in determining what products are needed where, when, and in what quantities. There are a number of factors that affect demand forecasting.
Some of the factors that influence demand forecasting are shown in Figure-2:
(i) Types of Goods
Affect the demand forecasting process to a larger extent. Goods can be producer’s goods, consumer goods, or services. Apart from this, goods can be established and new goods. Established goods are those goods which already exist in the market, whereas new goods are those which are yet to be introduced in the market.
Information regarding the demand, substitutes and level of competition of goods is known only in case of established goods. On the other hand, it is difficult to forecast demand for the new goods. Therefore, forecasting is different for different types of goods.
(ii) Competition Level
Influence the process of demand forecasting. In a highly competitive market, demand for products also depend on the number of competitors existing in the market. Moreover, in a highly competitive market, there is always a risk of new entrants. In such a case, demand forecasting becomes difficult and challenging.
(iii) Price of Goods
Acts as a major factor that influences the demand forecasting process. The demand forecasts of organizations are highly affected by change in their pricing policies. In such a scenario, it is difficult to estimate the exact demand of products.
(iv) Level of Technology
Constitutes an important factor in obtaining reliable demand forecasts. If there is a rapid change in technology, the existing technology or products may become obsolete. For example, there is a high decline in the demand of floppy disks with the introduction of compact disks (CDs) and pen drives for saving data in computer. In such a case, it is difficult to forecast demand for existing products in future.
(v) Economic Viewpoint
Play a crucial role in obtaining demand forecasts. For example, if there is a positive development in an economy, such as globalization and high level of investment, the demand forecasts of organizations would also be positive.