MANAGERIAL ECONOMICS- "DEMAND (OR SALES) ESTIMATION AND FORECASTING TECHNIQUES"

MANAGERIAL ECONOMICS-

 "DEMAND (OR SALES) ESTIMATION AND FORECASTING TECHNIQUES"

MEANING AND DEFINITION OF DEMAND OR SALES FORECASTING

A forecast is a prediction or estimation of future situation. Forecasts can be both physical as well as financial in nature. The more realistic the forecasts, the more effective decisions can be taken for tomorrow.

Demand forcasting is known as sales forecasting also. It means to estimate the sales for a certain future period. Under this technique, efforts are made to estimate the sales of a product or products of an enterprise for a certain future period of time. This forecast may be in terms of quantity as well as value. It has been defined as under:

1 “The company’s sales forecast is the expected level of company’s sales based on a chosen marketing plan and assumed environmental conditions.” – Philip Kotler

2. “Sales forcast is an estimate of sales during a specified future period, which estimate is tried to a proposed marketing plan and which assumes a particular set of uncontrollable and competitive forces.” –Condit and Still

Thus, it may be concluded that demand forecasting is the estimate of sales of the products of a company for a certain future period of time. This forecast is made on the basis of past performance and present circumstances.

IMPORTANCE OF DEMAND FORECASTING

Demand forecasting is an important economic tool, particularly in the present period of economic complications. It provides a base for economic planning. Its importance can be explained as follows:

(1) Helpful in Production Planning. Demand forecasting is the most reliable base of production planning Production programmes depend upon sales forecasts.

(2) Helpful in Manpower Planning. Demand forecasting helps in manpower planning also. It helps in determining production schedule which, in turn, helps in determining the number and quality of workers and employees required. Suitable recruitment policy can be framed on the basis of these estimates.

(3) Helpful in Inventory Control. Inventory control means to maintain proper levels of stock. It also depends upon sales forecasting because reliable sales forecasts help in determining how much stock should be maintained.

(4) Helpful in Financial Control. Demand forecasting provides a base which helps in determining the requirements of finance for an enterprise. The enterprise can prepare a plan for arranging and using the finance.

(5) Helpful in Increasing Sales. Demand forecasting helps in preparing sales forecasts for a future period of time. Necessary steps may be taken to achieve these targets and to intensity sales compaign in the areas in which sales are low.

(6) Basis of Planning. Demand forcasting is the base of economic planning. No enterprise can prepare its economic plans in the absence of demand forecasts. Demand forecasts are the base of sales budget, production budget, purchase budget, overheads budget, cash budget etc.

OBJECTIVES OF DEMAND (SALES) FORECASTING

SHORT TERM OBJECTIVES

Short-term Demand or Sales Forecasting are made for a period of less than three years. Important objectives of Short-term Sales Forecasting are as under :

1 Determination of a suitable production policy.

2. Regular supply of raw materials.

3. Best utilisation of machines.

4. Regular availability of labour.

5. Determination of price policy.

6. Setting sales Target establishing control and providing incentives.

7. Forecasting of Short-term Financial requirements.

[II] LONG-TERM OBJECTIVES:

Long-term Demand or Sales Forecastings are made for a period of more than three years. Important objectives of Long-term Sales Forecastings are as under:

1 Planning of Long-term production.

2. Planning of Plant Capacity.

3. Provision of Labour.

4. Forecasting of Long-term Financial Requirements.

Management of the enterprise must be very careful and vigilant while preparing Long-term Sales Forecastings because if these forecastings are Wrong, it can be very harmful for the enterprise.

IMPORTANCE OF SALES FORECASTING

Sales Forecasting is the base of marketing planning. Almost all the business and industrial enterprises produce goods in view of future demand Future demand is estimated on the basis of Sales Forecasting. If Sales forecastings of an enterprise are corrent, the enterprise may be successfull in producing goods and services in right quantity and at right time according to demand.

On the basis of these forecastings, the enterprise can arrange for adequate raw-materials, labour, capital, land and building, machinery etc. an enterprise can be successful in earning maximum profits only when it can sell its entire production at reasonable prices. To conclude, it can be said that Sales Forecasting helps in preparing such a production plan which may help in earning maximum profits at minimum cost.

PROCESS OF DEMAND FORECASTING

To make demand forecasts effective and realistic, it is necessary that a scientific process of demand forecasting should be adopted. Demand forecasting should be undertaken as a process and not as an activity. Following are the important steps of the process of forecasting.

(1) Setting Up of Objectives. The first step of the process of demand forecasting is to set its objectives. It should be determined clearly whether the forecasts are required for short term or long term, whether the forecasts are required in terms of quantity or value, whether the forecasts are required for products or sales territories. Time, energy and money involved in the process of demand forecasting should also be determined in advance.

(2) To Sub-divide the Task of Forecasting. To make the process of forecasting easy, it should be sub-divided. Products can be divided as capital goods and consumer goods, existing product and new product. Forecasts can be prepared on the basis of salesmen, sales territories or products. Sales territories can be divided on the basis of states, countries or regions.

(3) To Determine the Method of Forecsting. There are several methods of demand forecasting and every method has its own merits and de-merits. Every enterprise has to select a particular method or methods of deman forecasting. Such method or methods should be selected keeping in view all the relevant factors.

(4) To Determine Forecasts. After this, specific forcasts are determined. These forecasts should be determined keeping in view the present and future circumstances.

(5) Analysis of Actual Results. It is considered to be the most important part of the process of demand forecasting. Actual results of sales are collected and compared with demand forecasts. It helps in ascertaining the accuracy of demand forecasts and in determining variances between forecasts and actual results. Suitable corrective measures may be taken to remove these variances.

VARIOUS METHODS OF ESTIMATION FOR DEMAND (SALES) FORECASTING

Important Methods of Demand Estimation or Sales Forecasting are as follows:

(1) Survey of Buyer’s Intention. This is a direct method of Sales Forecasting. Under this method, the buyers are contacted and taken into confidence. The efforts are made to know the quantity which they would like to purchase during the period of forecasting. On the basis of these estimates, sales forecastings are prepared.

Merits: This method of sales forecasting is considered suitable, when-(i) The number of buyers is limited. (ii) It is expected that the buyers will give the estimates of the quantity which they are likely to purchase during the period of forecasting. (iii) This method is considered suitable only for short-term forecastings.

Demerits: (i) The requirements of buyers keep on changing from time to time, therefore, this method is not considered suitable for long-term forecastings. (ii) This method is not suitable when the number of buyers is large. (iii) This method is very expensive. (iv) The buyers do not co-operate in giving their estimates.

(2) Executive’s Judgement. Under this method, Sales Forecastings are prepared on the basis of knowledge and experience of executives of enterprise. For this purpose, a seminar is organised and sales estimates are prepared on the basis of discussion with executives and mutual discussion.

Merits : (i) This method is very simple and quick. Under this method, sales estimates can be prepared easily and quickly. (ii) Under this method, buyers’ investigation is not required. (iii) This method is based upon the knowledge and experience of top executives. Therefore, this method is considered very useful when there is a lack of adequate information and data.

Demerits : (i) Under this method, the liability of preparing sales estimates spreads over many executives, thus, there is lack of responsibility Determination

(ii) Such estimates are based upon opinions and experience and upon facts. (iii) This method is not reliable in all the conditions and cases because all the executives of the enterprise are not necessary to be the experts of preparing sales estimates.

(3) ‘Experts’ Opinion. Under this method, sales estimates are prepared on the basis of opinions of sales experts and on the basis of opinions of distributors. Some enterprises get the services of external experts and specified agencies also for this purpose. These experts and agencies charge some fees for their services.

Merits: (i) Under this method, sales estimates are based upon the knowledge and experience of sales experts, therefore, this method, is considered to be reliable. (ii) The enterprise is not required to spare its time on preparing sales estimates. (iii) This method is considered very suitable for new products because in case of new products, there is a complete lack of information and data.

Demerits: (i) This method is not suitable for preparing sales estimates on the basis of different products, different areas and different customers. (ii) This method is very expensive because under this method, the payments are to be made to the experts. (iii) This method lacks relaibility.

(4) Market Test Method. Under this method, a particular product is sold on trial in a particular part of the market for a certain period. Results obtained from such sale are taken to be the base for preparing sales forecasts and on these bases, the estimates are prepared for the whole market for the full year.

Merits: (i) This method is best for new products. (ii) This method is very suitable for evaluating the defects and shortcomings of the product. (iii) This method is based upon actual marketing results, therefore, sales estimates prepared under this method are considered to be very reliable.

Demerits: (i) This method takes much time. (ii) Under this method, the product is sold in a small part of the market only and the results of this sale are taken to be the base for preparing sales estimates for the whole market while teses results may not hold true for the remaining part of market.

(5) Trend Projection Method. Sales estimates can be prepared on the basis of trend projection or least square method. Under these methods, sales estimates are prepared on the basis of analysis of past data. Under these methods, there are two methods of preparing sales estimates–(A) Direct Method of Sales Forecasting. (B) Indirect Method of Sales Forecasting. Details in this regard are follows:

(A) DIRECT METHOD OF SALES FORECASTING

Under this method Y = a + bX formula is used for analysing sales trend. Here Y, means trend values for the current year, the value of ‘X’ is given and the values of ‘a’ and ‘b’ are calculated by using following equations :

 (B) INDIRECT METHOD OF SALES FORECASTING

Merits : (i) This method is very simple and economical. (ii) This method takes very little time, thus, there is an economy of time. (iii) If the factors affecting sales remain constant, the results of this method are most reliable.

Demerits : This method is based upon the assumption that all the factors affecting sales will remain constant during the period of forecasting but this assumption is not real, the fact is that the factors affecting sales always keep on changing. Therefore, the results of this method cannot be much relied upon.

(6) Economic Indicators Method. Under this method of Sales Forecasting, some certain economic indicators are determined for the purpose of preparing sales estimates. Then correlation is established between these economic indicators and sales data by using Least Square Method. For example, Number of Patients will serve as an economic indicator for the demand of Medicines. Similarly, the data of Population will serve as an economic indicator for the demand of Television.

Merits : (i) This method is very simple and economical. (ii) If other things remain the same, the results of this method are very reliable.

Demerits: (i) It is very difficult to determine economic indicators. (ii) With the use of this method it is very difficult to prepare sales estimates for a new product. (iii) This method is based upon the assumption that all other factors remain constant but in practical life it is very difficult. Therefore, results of this method cannot be very reliable.

PRACTICAL SOLVED PROBLEMS

TAJ DIRECT METHOD OF SALES FORECASTING

Example 1. Project the trend of Sales for next five years from the following information:

Years

1985 1986 1987 1988 1989

Years  300 350 300 375 425

 

Solution : When the number of items is odd. deviations should be calculated by taking middle year as the base. It makes the calculations easier.

METHODS OF DEMAND FORECASTING FOR A NEW PRODUCT

It is very easy to prepare Sales Forcast for an existing product in comparison to a new product because for preparing sales forecasts for an existing product, the help of past experience and data of earlier years may be taken but in case of a new product, no such help is available. Following methods can be used while preparing sales forecasts for a new product:

1 Substitute Approach. Under this method, sales forecasts for a new product are prepared on the basis of sales data and information of an existing product which may be substituted for the new product. These data and information are taken to be the base for preparing sales forecasts for new product

2. Evolutionary Approach. This method is based upon the assumption that when a new product come to the market, the buyers feel that the new product is an improved form of the existing product. Taking this view in mind, the stage of gradual development of the existing product is considered and sales forecasts for the new product are prepared on this basis.

3. Buyer’s Or Customer’s view. Under this method of sales forecasting. All the possible buyers or customers of the product are contacted and taken into confidence. Attempts are made to know the quantity which they are likely to purchase during the period of forecasting. Sales forecasts are prepared on the basis of information obtained from these buyers or customers.

4. Experts’ Openion. Under this method, opinion of sales experts and distributors are obtained and sales forecasts are prepared on the basis of such opinion. Some business enterprises get the services of specific agencies and experts also for this purpose. These agencies and experts charge a certain remuneration for their services.

5. Market Test Method. Under this method, when a new product is introduced. It is not sold in the whole market at one time. Rather, it is offered for sales in a certain part of the market, that too for a certain period on trail basis. The results of such sales are obtained and sales forecasts for the product are prepared on the basis on these results.

TYPES OF FORECASTING

Forecasts can be broadly classified into : (i) Passive Forecast and (ii) Active Forecast. Under passive forecast prediction about future is based on the assumption that the firm does not change the course of its action. Under active Forecast, prediction is done under the condition of likely future changes actions by the firms.

From the view point of time span’, forecasting may be classified into two, viz., (i) short term demand forecasting and (ii) long term demand forecasting. In a short run forecast, seasonal patterns are of much importance. It may cover a period of three months, six months or one year. It is one which provides information for tactical decisions. Which period is chosen depends upon the nature of business. Such a forecast helps in preparing suitable sales policy. Long term forecasts are helpful in suitable capital planning. It is one which provides information for major strategic decisions. It helps in saving the westages in material, man hours, machine time and capacity. Planning of a new unit must start with an analysis of the long term demand potential of the products of the firm.

There are basically two types of forecast, viz, (i) External or national group of forecast, and (ii) Internal or company group forecast. External forecast deals with trends in general business. It is usually prepared by a company’s research wing or by outisde consultants. Internal forecast includes all those that are related to the operation of a particular enterprise such as sales group, production group, and financial group. The structure of internal forecast includes forecast of annual sales, forecast of products cost, forecast of operating profit, forecast of taxable income, forecast of cash resources, forecast of the number of employees, etc.

At different levels forecasting may be classified into (i) Macro-level forecasting, (ii) Industry-level forecasting, (iii) Firm-level forecasting and (iv) Product line forecasting. Marco-level forecasting is concerned with business conditions over the whole economy. It is measured by an appropriate index of industrial production, national income or expenditure Industry-level forecasting is prepared by different trade associations. This is based on survey of consumers’ intention and analysis of statistical trends. Firm-level forecasting is related to an individual firm. It is most impoortant from managerial view point. Product line forecasting helps the firm to decide which of the product or products should have priority in the allocation of firm’s limited resources.

There are different forecasts for different types of products like (i) Forecasting demand for non-durable consumer goods, (ii) Forecasting demand for durable consumer goods, (iii) Forecasting demand for capital goods, and (iv) Forecasting demand for new products.

NON-DURABLE CONSUMER GOODS

These are also known as “single-use consumer goods’ or perishable consumer goods. These vanish after a single act of consumption. These include good like food, milk, medicine, fruits, etc. Demand for these goods depends

upon household disposable income, price of the commodity and the related goods and population and characteristics. Symbolically,

Dc = f(y, s, p, P.) Where,

Dc = the demand for commodity c

y = the household disposable income

s = population

p = price of the commodity C

P = price of its related goods

(1) Disposable income expressed as De = f(y) i.e., other things being equal, the demand for commodity c depends upon the disposable income of the household. Disposable income of the household is estimated after the deduction of personal taxes from the personal income. Disposable income gives an idea about the purchasing power of the household.

DURABLE CONSUMER GOODS

These goods can be consumed a number of times or repeatedly used without much loss to their utility. These include goods like car, T.V., air-conditioners, furniture etc. After their long use, consumers hava a choice either these could be consumed in future or could be disposed of.

ESSENTIALS OF A GOOD SALES FORECASTING SYSTEM

A good sales forecasting system must possess the following qualities :

1 Simplicity. The method followed for preparing sales forecasts should be simple. If the method followed for this purpose is complicated or is of the technical nature, the person responsible fore preparing sales forecasts will not take interest in his work and, as a result of it, sales forecasts may be wrong. Sometimes the information required for sales forecasting are to be collected from outside persons also. If the method of sales forecasting is complicated, these outside persons will not cooperate in providing such information.

2. Accuracy. Sales forecasts are the base of marketing planning. Therefore, sales forecasts should be accurate and reliable also. If the sales forecasts are accurate and reliable, it will help in preparing effective marketing plans and programmes.

3. Availability. The objects and scope of sales forecasting should be determined keeping in view the availability of required data. If the required data are not easily available, sales forecasts will not be prepared in time.

4. Stability. Sales forecasts should be prepared in the manner that there should be no hope of changes in the near future, or the possibility of such changes should minimum so that the marketing plan prepared on the basis of these data may be relied upon.

5. Utility. Sales forecasts should be prepared in the manner that the management may understand the method of sales forecasting and the management may have a faith in the techniques of sales forecasting.

6. Economy. The method followed for preparing sales forecasts should be economical also. There should be minimum involvement of time and labour.

THE ROLE OF SALES FORECASTING IN MARKETING PLANS

Almost all the decisions of the business enterprise are related with sales forecasting in one way or the other because all the decisions in the field of planning depend to a large extent upon sales forecasting. Therefore, sales forecasting has an important role to play in the management and operation of all the business enterprises. The fact is that the success of a business or industry enterprise depends to a large extent upon sales forecasting. Sales forcasting provides a base for marketing planning to the marketing manager. Importance of sales forecasting in marketing planning can be explained as under:

1 Sales Forecasting is the Basis for Marketing Planning. No effective marketing plan can be prepared unless and until it is based upon effective sales forecasts. For example, if marketing manager does not have sales forecasts for the products of his enterprise, he cannot prepare any marketing programme or production schedule for these produts. If he prepares any plan or policy or programme, it will be baseless. Thus, sales forecasts provide a base for determining production policy, advertisement policy, sales promotion policy, price policy and physical distribution policy etc.

2. Discovery of Marketing Opportunities. Sales forecasting provides an effective tool for the discovery of marketing opportunities. Discovery of marketing opportunities helps in planning and preparing marketing programme. Thus, sales forecasting motivates all the employees of marketing department to work with greater enthusiasm.

3. Sales Forecasting helps the Marketing Manager for Marketing Planning. Sales forecasting helps in the discovery of marketing opportunities. It helps them in evaluating these opportunities also. It provides them an opportunity to evaluate their abilities and potentialities. In other words, sales forecasting provides an incentive for all the employees of marketing department to make more efforts to achieve the marketing objectives of the enterprise in a better way.

4. Sales Forecasting reduces the Marketing Risk. Sales forecasting helps in establishing the marketing risks. Establishment of marketing risks helps the marketing managers to prepare themselves to face these risks. They work with greater precaution and prepare marketing planning and policies in the manner that these risks may be minimised.

5. Helpful in Control. Sales forecasting helps in establishing those marketing areas and activities which require greater control. Marketing manager can prepare marketing plans and progarmmes according to it so that they may concentrate upon those areas and activities. Thus, it may be concluded that sales forecasting has an important role to play in marketing planning because the building of marketing planning is to be based upon the foundation of sales forecasting.

[II] FACTORS AFFECTING SALES FORECASTING

Following are the factors affecting sales forecasting :

1 General Business Conditions. Marketing manager must study the general business conditions very carefully while preparing sales forecasts. General business conditions include– (i) General economic conditions of the country, (ii) Population, (iii) Distribution of income and wealth in the country, (iv) General traditions and customs. (v) Fashion, (vi) Seasonal fluctuations. (vii) Per capita income, (viii) Government policy, etc.

2. Conditions within the Industry. Every business enterprise is only a unit of a particular industry. Sales of that business enterprise is only a part of the total sales of that industry. Therefore, while preparing sales forecasts for a particular business enterprise, it becomes necessary to study the fluctuations taking place in the demand of the whole industry because the demand of a particular business enterprice is likely to fluctuate according to the demand of the industry. Conditions within the industry that should be considered include the following-(i) Number of units within the industry, (ii) Design of product, (iii) quality of product, (iv) Price policy, (v) Product line of the enterprise, (vi) Stage of competition within the industry, (vii) Expected improvements in the product, etc.

3. Internal Factors of the Enterprise. Internal factors of the enterprise also have an important role to play in the process of sales forecasting of an enterprise. These are the factors that may be controlled by the marketing manager to a large extent. These factors include the following-(i) Plant capacity of the enterprise, (ii) Quality of the product, (iii) Price of the product, (iv) Advertisement and distribution policies of the enterprise, etc.

4. Factors Affecting Export Trade. If a business enterprise is engaged in export trade also, it should consider the factors affecting export trade also while preparing its sales forecasts. These fectors include the following Import and export controls, (ii) Terms and conditions of export, (iii) International policy, etc.

5. Market Behaviour. An important factor to be considered by marketing manager while preparing sales forecasts for his enterprise is market behaviour. It implies that the marketing manager should study whether there is any important change in the pattern of demand for the product for which sales forecasts are being made. For this purpose, the marketing manager Should study the law of demand and the factors affecting the demand of his product

Above study makes it clear that the marketing manager should consider various factors carefully while preparing sales forecast for his product.

Demand Estimation Forecasting Techniques

[III] LIMITATIONS OF SALES FORECASTING

Some important limitations of sales forecasting are as follows:

1 Lack of Efficient and Experienced Forecasters. Success of sales forecasts depends to a large extent upon the ability and experience of forecasters. Unfortunate fact is that there is a lack of efficient and experienced forecasters. If the forecasters are inefficient and unexperienced, sales forecasts prepared by them may be wrong.

2. Lack of Sales History. Sales forecasts are generally based upon past experience and sales data of the product during past years. In case of new product, the task of sales forecasting becomes very different because in this case, past data are not available. Therefore, it becomes very difficult to forecast the demand of a new product.

3. Chang in Consumers’s Needs, Fashion and Style etc. Demand of a product depends to a large extent upon the needs, tastes, fashion and style etc.. of consumers but all of these factors keep on changing. Thus, it becomes very difficult to prepare sales forecasts for a product. For example, if a particular product of an enterprise becomes popular among consumers, the demand of such product will increase many times but if a product of an enterprise does not become popular among consumers, the demand of such product will decrease heavily. Therefore, it becomes important for the marketing manager to consider these factors very carefully while preparing sales for his product.

4. Psychology of Consumers. Demand of a product depends to some extent upon the psychology of consumers also but it is very difficult to study the psychology of consumers correctly. A consumer is a rational human being. It is not necessary for a consumer to tell in advance the things that he would like to purchase. Moreover, the psychology of consumer keeps on changing from time to time and from product to product. Therefore, the psychology of consumers is an important limitation of sales forecasting. Marketing managers should consider this factor also while preparing sales forecasts.