Everything You Need to Know About Demand Forecasting

Here’s a quick overview of the demand forecasting process and techniques.

What is Demand Forecasting?

Demand Forecasting is the process in which historical sales data is used to develop an estimate of an expected forecast of customer demand. To businesses, Demand Forecasting provides an estimate of the amount of goods and services that its customers will purchase in the foreseeable future. Critical business assumptions like turnover, profit margins, cash flow, capital expenditure, risk assessment and mitigation plans, capacity planning, etc. are dependent on Demand
Forecasting.

Demand Forecasting Types

Demand Forecasting can be broadly classified based on the level of detailing, time span considered and the scope of market considered.

Outlined below are the major types of Demand Forecasting:

Passive Demand Forecasting: Passive Demand Forecasting is carried out for stable businesses with very conservative growth plans. Simple extrapolations of historical data is carried out with minimal assumptions. This is a rare type of forecasting limited to small and local businesses.
Active Demand Forecasting: Active Demand Forecasting is carried out for scaling and diversifying businesses with aggressive growth plans in terms of marketing activities, product portfolio expansion and consideration of competitor activities and external economic environment.
Short-term Demand Forecasting: Short-term Demand Forecasting is carried out for a shorter term period of 3 months to 12 months. In the short term, the seasonal pattern of demand and the effect of tactical decisions on the customer demand are taken into consideration.
Medium to long-term Demand Forecasting: Medium to long-term Demand Forecasting is typically carried out for more than 12 months to 24 months in advance (36-48 months in certain businesses). Long-term Forecasting drives the business strategy planning, sales and marketing planning, financial planning, capacity planning, capital expenditure, etc.
External macro level Demand Forecasting: This type of Forecasting deals with the broader market movements which depend on the macroeconomic environment. External Forecasting is carried out for evaluating the strategic objectives of a business like product portfolio expansion, entering new customer segments, technological disruptions, a paradigm shift in consumer behavior and risk mitigation strategies.
Internal business level Demand Forecasting: As the name suggests, this type of Forecasting deals with internal operations of the business such as product category, sales division, financial division, and manufacturing group. This includes annual sales forecast, estimation of COGS, net profit margin, cash flow, etc.

Demand Forecasting Examples

Some real-world practical examples of Demand Forecasting are – A leading car maker, refers to the last 12 months of actual sales of its cars at model, engine type, and color level; and based on the expected growth, forecasts the short-term demand for the next 12 month for purchase, production and inventory planning purposes.

A leading food manufacturing company refers to the last 24 months of actual sales of its highly seasonal products like soups and mashed potatoes. An analysis is carried out at the flavor and packaging size level. Then based on the market potential, demand is forecasted for the next 12 to 24 months for sourcing of key ingredients like tomatoes, potatoes, etc. and for capacity planning and evaluating the need for external co-packing.

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 Demand Forecast, 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.

Short to medium term tactical plans like pre-building, make-to-stock, make-to-order, contract manufacturing, supply planning, network balancing, etc. are execution based. Demand Forecasting also facilitates important management activities like decision making, performance evaluation, judicious allocation of resources in a constrained environment and business expansion planning.

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:

1. Qualitative methods:
  - The Delphi Technique: A panel of experts are appointed to produce 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.
  - Sales Force 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 Demand Forecast after management’s judgment.
  - Market Research: In 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.

1. Quantitative methods:
  - Trend projection method: 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 analysis like 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 the 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.

Demand Forecasting Objectives

Objectives of Demand Forecasting include Financial planning, Pricing policy, Manufacturing policy, Sales, and Marketing planning, Capacity planning and expansion, Manpower planning and Capital expenditure.

Demand Forecasting Models

Based on the specific requirements of a business or a product category, a customized Demand Forecasting model can be developed. Such a model is an extension or combination of various Qualitative and Quantitative Methods of Demand Forecasting. The task of developing a customized model is often iterative, highly detailed and expertise-driven and can be accomplished by implementing a suitable demand management software

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