What is Demand Forecasting? Types, Steps, Objectives, Importance, Examples


Meaning of Demand Forecasting

Demand forecasting is a process of predicting future demand for company’s product over a definite period of time. It is simply all about making estimations about the behavior of customers using historical data and various other information. Demand forecasting gives business an idea about the quantity of goods or services which are likely to be purchased by people in foreseeable future. It is very important element for organization as it provides them with valuable information regarding their potential in current market and other markets. Management of company are able to take informed decisions related to pricing, market potential and business growth strategies. 

Every business operates in world of uncertainty, tough competition and higher risk. A business come across different risks which are either internal or external to its operations such as attrition, technology, inflation, recession, variations in laws etc. There is a need to take right decisions and proper planning by every business about future events in such competitive market conditions. Demand forecasting assist them in decisions related to sales, production, inventory management and whether to enter a new market or not by providing idea on future possibilities. 

Types of Demand forecasting

Various types of demand forecasting are well-explained in points given below: –

  1. Passive demand forecasting: Passive demand forecasting is the simplest type of demand forecasting used for stable business with conservative growth plans. In this model, a simple extrapolation of past data is done with minimal assumptions for predicting the future. It does not require to study the economic trends or use any statistical methods. This type of forecasting is more probably used in case of local and small businesses. 
  2. Active demand forecasting: This type of forecasting is carried out for business having an aggressive plan of growth. A active forecasting model studies your marketing research, market campaigns and expansion plans. It takes into consideration the external factors such as economic outlook, economic environment, competitor activities and growth projection for market sector. Active forecasting model is more favorable for starts-up business having lack of historical data and need to make assumptions on external data basis. 
  3. Short-term demand forecasting: The short-term demand forecasting model is used to make predictions for shorter time period of 3 to 12 months. It facilitates in managing the just-in time supply chain thereby responding quickly to varying customer demand. This model of demand forecasting takes into consideration the seasonal pattern of demand as well as effect of tactical decisions on customer demand. 
  4. Long-term demand forecasting: Long-term demand model is meant for making projections of more than 12 months to 48 months. It is treated as a roadmap which enables business in shaping its growth trajectory. The long-term demand forecasting enables in sales and marketing planning, financial planning, planning of business strategy, capital planning, capital expenditure etc. 
  5. External macro forecasting: This forecasting model deals with trends in broader market which are dependent upon the macroeconomic environment. External macro forecasting studies how these trends influence your goals and provide direction for reaching to those goals. It evaluates strategic objectives of organization such as expansion of product portfolio, technological disruptions, risk mitigation strategies and entering new segments of customer.  
  6. Internal business forecasting: It is concerned with internal operations of business which determines its capability for growth. The internal operations are product category, manufacturing group, financial division and sales division. Internal business forecasting helps in uncovering limitations which may obstruct your growth and highlight areas of opportunities available to business. It is an efficient tool in making realistic projections. 

Steps in Demand Forecasting

Following steps are involved in a process of demand forecasting: –

  1. Identifying objectives: In first step, the purpose or objectives for which the demand forecasting is to carried out should be clearly specified. The objective need to be well-defined in terms of short or long-term demand, firm’s market share, the whole market or only a segment of it for firm’s product etc. Proper specification of objective will provide a right direction to whole research. 
  2. Determining time perspective: The demand may be forecasted either for short period or long period depending upon the objectives of firm. In case of short-term demand forecasting that is for next 2 to 3 years, many determinants of demand do not change significantly and can be taken as constant. Whereas the demand determinants change significantly in case of long run forecasting. It is required to clearly specify the time perspective of forecasting to be done.
  3. Choosing the forecasting method: Now a forecasting method is chosen once the objectives and time perspective is specified. There are different methods of demand forecasting which are categorized into 2 types: survey methods and statistical methods. In survey method, opinions polls and consumer survey methods are used. Whereas econometric, trend projection and barometric methods are used in statistical methods. Both of these method type differ from one another on the basis of type of data required, forecasting purpose, time frame of forecasting and availability of data. Only that method should be chosen which best suits the requirement.  
  4. Collection of data and data adjustment: Now the data required for doing forecasting is selected which can be primary or secondary data or even both. The first-hand data which is not collected before is termed as primary data. Whereas the data already collected in past by someone is known as secondary data. Sometimes the data is even adjusted or manipulated when the required set of data is not available. This is done to build consistency of data with the data required. 
  5. Interpretation of results: Now finally the demand is forecasted for predefined time period. It is done at last stage once the forecasting method is finalized and required set of data is collected. Usually, the equations are used for showing the estimates while results are interpreted in an easy and usable form. 

Demand forecasting is carried out in a right manner and the required objectives are attained if abovementioned steps are followed systematically. 

Objectives of Demand Forecasting

The objectives of demand forecasting are summarized in points below: –

  1. Formulation of production policy: Demand forecasting helps in formulation of suitable production policy by estimating demand for future. A business can accordingly procure and maintain sufficient amount of raw materials to ensure interrupted production for future demands as per the forecast. This will enable to cover the gap in between the demand and supply of product.
  2. Price policy formulation: It is one of the most important objective of demand forecasting. This enables business in formulating an effective price mechanism so that level of prices does not fluctuates much during the inflation or depression phase. 
  3. Control of sales: Demand forecasting enables in controlling the sales by doing sales forecasting of product or services on a regional basis. This way the sales target is set for each area and then performance of sales is evaluated on this basis. 
  4. Finance arrangements: It help organization in maintaining proper liquidity by making estimations on funds requirements. By forecasting the sales and liquidity requirements of business, cost of obtaining finance is minimized. 
  5. Regulates supply of materials: Demand forecasting regulate the supply of raw materials by determining the level of production within the business. This way a continuous supply of raw materials can be planned leading to better inventory management.  
  6. Regulates labor supply: Labor expenses is important component in cost of production. Proper sales forecasts enable business in acquiring appropriate and skilled labor. 
  7. Deciding production capacity: Demand forecasting assist business in properly deciding its production capacity. A firm can easily determine the size of production plant needed for fulfilling the production requirements with the help of sale forecast.
  8. Capital restructuring: Demand forecasting for long term can enable business in financial planning for long-term. It can raise require funds at reasonable rates and suitable terms form distinct sources including internal as well as external source.

Importance of Demand Forecasting

The importance of demand forecasting is as given below: –

  1. Producing desired output: Demand forecasting enables business in producing the desired output by pre-determining the required production level. Organization can easily arrange for needed factors of production beforehand so that there is no hindrance to carry out the production activities. 
  2. Estimating probable demand: It assists in doing right planning of business activities by accessing the probable demand of products in a given time period. Demand forecasting avoid instances of merely making assumptions for demand by business enterprise. 
  3. Better control: Demand forecasting enables in developing proper understanding of cost budgets and profit analysis. Having a good understanding on all this facilitate to exercise better control on business activities. 
  4. Forecasting sales figures: Sales forecasting involves predicting the sale figures of organization for a given period of time. Demand forecasting make estimations about sales figure using historical data and studying current market trends. 
  5. Ensure stability: Demand forecasting facilitate the business organization in stabilizing their operations. It helps them in formulating suitable policies in order to meet cyclical as well as the seasonal fluctuations within the economy.   
  6. Controlling inventory: Demand forecasting estimate the future demand for business products and services. This way organization are able to do pre-planning for acquiring raw materials, spare parts, semi-finished goods etc.