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To see the future is mankind’s old wish and ambition to become more powerful and take correct decisions in the present time to make the future bright. It is equally applicable for business decisions, wherein all top executives want to forecast the demand accurately and practically to align their activities in such a manner, so businesses can cater to the maximum possible demand of customers and increase revenue by reducing inventories. It is most important to know future demand as it is the foundation stone for business planning.
Under “Demand Management Trilogy”, I have already published the first article on “Demand Planning” wherein you can understand it very comprehensively. In this raw, I am publishing the second article on “Demand Forecasting” which is a buzzword in the Sales and Marketing industry, and give insights to top-management for all important business decision making which helps the business to meet future customer demand.
WHAT IS DEMAND FORECASTING?
Demand forecasting is the process of estimating consumer demand for particular goods or services by using historical sales data, market conditions, competitor’s strategies and plans the production activities accordingly to meet the expected demand. It affects critical business assumptions like turnover, profit margins, cash flow, capital expenditure, risk assessment, and mitigation plans, production capacity planning, etc. Demand forecasting is important for industrially empowered countries where ample supply is available but demand is uncertain, but it is more important in developing countries like India where supply is limited and demand is more but fluctuating frequently. It is dependent on the marketing plan, environmental conditions, competition from similar products, and economic conditions of customers.
DEMAND FORECASTING OBJECTIVE
Objectives of Demand Forecasting include Financial planning, Pricing policy, Manufacturing policy, Sales and Marketing planning, Capacity planning and expansion, Manpower Planning, and Capital expenditure.
DIFFERENCE BETWEEN DEMAND PLANNING AND DEMAND FORECASTING
Demand forecasting is merely one of several components of demand planning. Whereas Demand planning is defined as using forecasts and experience to estimate the demand for various items at various points in the supply chain. Demand planning uses the forecasts provided by demand forecasting to adjust the supply chain to accommodate fluctuations in demand.
TYPES OF DEMAND FORECASTING
FACTORS AFFECTING DEMAND FORECAST BASED ON NATURE OF PRODUCT CATEGORY
GENERAL APPROACH TO DEMAND FORECASTING:
1. Identify and clearly state the objectives of forecasting—Short-term or long-term, market share or industry as a whole.
2. Select a suitable method of forecasting.
3. Identify the variables affecting the demand for the product.
4. Collect and gather relevant data and approximations to relevant data to represent the variables.
5. Determine the most probable relationship between dependent and independent variables through the use of statistical techniques.
6. Prepare the forecast and interpret the results. Interpretation is more important to management.
7. For forecasting the Company’s share in the demand two different assumptions can be made:
(a) The ratio of the company sales to the total industry sales will continue as in the past.
(b) On the basis of an analysis of likely competition and industry trends, the company may assume a market share from that of the past.
8. Forecasts may be made either in terms of physical units or in terms of the currency of sales volumes.
9. Forecasts may be made in terms of product groups and then broken for individual products on the basis of past percentages. These products groups may be divided into individual products in terms of sizes, brands, labels, colours etc.
10. Forecasts may be made on an annual basis and then divided month-wise or week-wise on the basis of past records.
11. For determining the month-wise break-up of the forecast sales of a New Product, either use may be made of other firm’s data is available or some survey may be necessary.
DEMAND FORECASTING METHODS
One of the most important steps of the Demand Forecasting process is the selection of the appropriate method for Demand Forecasting. Demand can be forecasted using (A) Qualitative methods or (B) Quantitative methods as explained below:
The Delphi Technique: A panel of experts is appointed to generate a Demand Forecast. Each expert is asked to generate a forecast of their assigned specific segment. After the initial forecasting round, each expert reads out their forecast and, in the process, each expert is influenced by other experts. A consequent forecast is again made by all experts and the process is repeated until all experts reach a near consensus scenario.
SalesForce Opinion: The Sales Manager asks for inputs of expected demand from each Salesperson in their team. Each Salesperson evaluates their respective region and product categories and provides their individual customer demand. Eventually, the Sales Manager aggregates all the demands and generates the final version of the Demand Forecast after management’s judgment.
Market Research: In the market research technique, customer-specific surveys are deployed to generate potential demand. Such surveys are generally in the form of questionnaires that directly seeks personal, demographic, preference, and economic information from end customers. Since this type of research is on a random sampling basis, care needs to be exercised in terms of the survey regions, locations, and demographics of the end customer. This type of method could be beneficial for products that have little to no demand history.
B. Quantitative methods:
Trend projection method: The trend projection method can be effectively deployed for businesses with a large sales data history of typically more than 18 to 24 months. This historical data generates a “time series” which represents the past sales and projected demand for a specific product category under normal conditions by a graphical plotting method or the least square method.
Barometric technique: Barometric technique of Demand Forecasting is based on the principle of recording events in the present to predict the future. In the Demand Forecasting process, this is accomplished by analyzing the statistical and economic indicators. Generally, forecasters deploy statistical analyses like the Leading series, Concurrent series, or Lagging series to generate the Demand Forecast
Econometric forecasting technique: Econometric forecasting utilizes autoregressive integrated moving-average and complex mathematical equations, to establish relationships between demand and factors that influence demand. An equation is derived and fine-tuned to ensure a reliable historical representation. Finally, the projected values of the influencing variables are inserted into the equation to generate a forecast.
CRITERIA OF A GOOD FORECASTING METHOD
Each demand forecast has its own Pros and Cons. Hence, it is very important to choose wisely based on the product, market size, competitor’s stand, and cost factor. However, irrespective of a Demand Forecasting method, there are some criteria that need to be taken care of.
- Accuracy: Accuracy is the first and foremost criteria for good forecasting and to obtain an accurate forecast, it is essential to check the accuracy of past forecasts against present performance and of present forecasts against future performance.
- Acceptability: The executive should have a good understanding of the technique chosen and they should have confidence in the techniques used. Acceptability and understanding of the technique will improve the confidence of executives and improve the accuracy of the forecast.
- Durability: Frequently used forecasts based on past data have a short life cycle and cannot be used for a long time. The durability of the forecasting power of a demand function depends partly on the reasonableness and simplicity of functions fitted, but primarily on the stability of the understanding relationships measured in the past. The higher cost can be affordable for the method which has high durability.
- Flexibility: The flexibility of the demand function makes it more generic and could be set up easily for a variety of forecasting requirements. A set of variables whose coefficient could be adjusted from time to time to meet changing conditions in a more practical way to maintain intact the routine procedure of forecasting.
- Availability: Immediate availability of data is a vital requirement. The techniques employed should be able to produce meaningful results quickly. Delay in result will adversely affect the managerial decisions.
- Economy: Cost is a primary consideration that should be weighed against the importance of the forecasts to the business operations.
- Simplicity: Statistical and econometric models are certainly useful but they are intolerably complex. To those executives who have a fear of mathematics, these methods would appear to be like Chinese. The procedure should, therefore, be simple and easy so that the management may appreciate and understand why it has been adopted by the forecaster.
- Consistency: The forecaster has to deal with various components which are independent, therefore he has to make an adjustment in one component to bring it in line with a forecast of another, so the outcome will be consistent.
The ideal forecasting method is one that yields returns over cost with accuracy, seems reasonable, formalized for reasonably long periods, adapts to new circumstances, and can give up-to-date results. The method may be different for different products. The forecaster may try one or the other method depending upon his objective, data availability, the urgency with which forecasts are needed, resources he intends to devote to this work, and the type of commodity whose demand he wants to forecast.
IMPORTANCE OF DEMAND FORECASTING
Demand Forecasting is the pivotal business process around which strategic and operational plans of a company are devised. Based on the same, strategic and long-range plans of a business-like budgeting, financial planning, sales and marketing plans, capacity planning, risk assessment, and mitigation plans are formulated. It is helpful in the following manners.
1. Essential to Produce the Required Quantities at the Right Time: Accurate demand forecasting is essential for a firm to enable it to produce the required quantities at the right time and arrange well in advance for the various factors of production. The producer can frame a suitable production policy. The firm can reduce the costs of purchasing raw materials.
2. To Adopt Suitable Price Policy: It also enables the firm to adopt a suitable price policy. It is on the basis of demand and sales forecasts that arrangements are made for raw materials, equipment, machine, accessories, labour and buildings well in advance and at the right time.
3. It is Helpful in the Maximisation of Profit: A firm can maximise its profits only when it produces on the basis of the demand for its products. There will be no problem of over and under production and it will reduce or have control over costs, the profits will certainly go up. The importance of sales forecasting is much more on a large scale or seasonal industries.
4. Importance from National Point of View: On the national level, demand forecasts of particular products may provide a guideline for demand forecasts for related industries. i.e. A demand forecasts for cotton textile may provide an idea of probable demand for textile machinery, readymade garments, dyestuff industries. The government on the basis of sales forecasts may decide whether imports are necessary to meet the deficit in the domestic demand or may provide export incentives for any surplus. Thus, demand forecasts are useful to the firm, industry and also to the government.
Demand Forecasting in Supply Chain Management
In the field of Supply Chain, there are mainly 3 types of forecasting:
- Demand forecasting: Investigation of the companies demand an item or SKU, to include current and projected demand by industry and product end use.
- Supply forecasting: Collection of data about the current producers and suppliers, as well as technological and political trends that might affect supply.
- Price forecast: This is based on information gathered and analysed about demand and supply. Provides a prediction of short- and long-term prices and the underlying reasons for those trends.
All the above three forecasts help in the following manner to improve Supply Chain.
1. Increased Customer Satisfaction: Customer is the center point for the Supply Chain and it is the prime responsibility of the supply chain to provide them with the right product at the right time. This advantage of forecasting in business will help predict product demand so that enough product is available to fulfill customer orders on a timely basis. The importance of Demand Forecasting is much higher in Made-to-Order (MTO), Assemble-to-Order (ATO), or JIT Supply Business.
2. Reducing inventory stockouts: In any format either Just In Time (JIT) or long lead time, accurate demand forecasting and material requirement planning
3. Effective Production Scheduling: Effective demand forecasting can help S&OP and the Production team to plan their activities in an effective and efficient manner as they get ample lead-time to deliver the product to the market.
4. Lowering safety stock requirement: A good demand forecasting process will have a direct impact on the planning of inventory levels like developing production requests for manufacturing operations, planning for new product launches, planning for a promotional activity, and planning for seasonal variations in demand. If a business is using forecasting to plan these scenarios then there is no need to carry high safety stocks to manage those events.
5. Reducing product obsolescence costs: If the demand forecast is effective and accurate then there will not be any undesired inventory pile up at any point of the Supply Chain and chances of obsolesced inventory will be greatly reduced. This closely links to reduced order sizes as a smaller volume of the inventory will be in stock and demand forecast accuracy.
6. Better Shipping or Logistics Management: Shipping or Logistics shall be the most important function in the supply chain which delivers ready product from the manufacturing point to the customer’s hand. Hence, we should consider them as a part of the forecasting team and proper forecasting will help the shipping team to better align transportation of products from the production plant to market.
FORECASTS IN INDIA
In most of the industrially advanced countries, there are specialized agencies who are looking after demand forecasting activities. In India, businessmen are not interested in making scientific forecasts and they are more dependent on previous data, word of mouth, and chance. Looking at this attitude, sufficient data are not available to make reliable forecasts. Statistics alone do not forecast future conditions. Judgment, experience, and knowledge of the particular trade are also necessary to make proper analysis and interpretation and to arrive at sound conclusions. However, in recent years after the introduction of Industry 4.0 and the “Make in India” concept, there is a shift in the mindset of Indian businessmen which gives importance to Demand Forecasting in the coming years.
Thus, Demand Forecasting is enjoying prime importance for Business activity planning and it can become a game-changer for any industry. Effective demand forecasting will help the company to effectively manage Inventory Planning, production planning, Sales and Marketing activities, Promotional schemes, and customer satisfaction. It gives the edge to any firm over a competitor’s firm and helps to go closer to the endpoint of the supply chain – The King Customer.