Demand Forecasting 101: Meaning, Types and Methods

Tanisha Achrekar — Thu, 29 Apr 2021 05:35:05 +0000

In grocery stores, you might have observed that some products are available in more quantity than others. The store owner would have more of some biscuit packets and barely a few or none of the others. Even from the manufacturer’s end, some products are manufactured more than others. Why would manufacturers, suppliers, or store owners keep/produce more stock of some products and less of others? The reason behind their actions is simply an estimated demand. The grocery store owner observes his usual sales and estimates which products are going to be sold more and which less. Then according to the estimated demand, he places the order to his supplier. The grocery owner here, without even realizing, conducted the process of demand forecasting.

Defining and understanding demand forecasting

Demand forecasting is a technique of estimating the demand of consumers for a product or service in future. Historic sales along with other information are taken into consideration while forecasting the demand for a product or service. A demand forecasting process gives a business the valuable information needed in order to understand the current consumers and potential consumers. This analysis helps the business to create a pricing strategy, marketing analysis, production along with other critical business decisions.

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If your business is new, active demand forecasting seems the perfect fit for you.

Types of demand forecasting

Depending on your business, there are several ways to conduct demand forecasting. Every forecasting will give you a different result. If resources and time permit, using multiple forecasting helps a lot to understand the consumer demand better. As it will help you in understanding the difference in predictions and the reason behind it.

Active demand forecasting

If your business is new, active demand forecasting seems the perfect fit for you. Active forecasting is where demand is derived based on external factors. This is because since the business is new, there is barely some or no internal information available to analyze. Instead during active forecasting, the focus lies on marketing campaigns, expansion plans, and marketing research.

Passive demand forecasting

Passive demand forecasting is the smoothest and easiest way of forecasting for your business. This is because the sales from the past are used to predict the future sales of the product/service. Also, there are no statistical methods or economic trends that are needed to be studied for this type. It is completely data-driven. The key here is to have tangible and reliable data that you can use. The more reliable your data is the more accurate your demand estimation will be. However, during passive forecasting, the underlying assumption is that your sales will remain the same as last year approximately. Hence, it is a great model for a business that is doing good sales and plans to continue that. This forecasting is more focused on maintaining the existing stability rather than growth.

Internal demand forecasting

Internal demand forecasting helps in understanding that even though the consumers demand increases, is the business capable enough to handle it? Does it have enough resources to meet those demands? Internal forecasting helps in understanding how the operations are going and their existing capability. It helps in understanding what is working for the business and what isn’t. One of the parameters taken into consideration during internal estimation of demand is profit margins, finances of the business, working capital, and supply chain operations. The reason why finances form the basis of this forecasting is to understand does the business have enough funds and resources to meet consumer demand.

External macro forecasting

What is happening in the industry, the market or the overall economy is taken into consideration during the external macro forecasting. It focuses on the external massive factors. The forecasting helps in understanding how the macro external factors are going to impact the consumer demand of your business. A simple example is how the COVID-19 pandemic, an external factor affected the demand of several businesses. Taking external market forces into consideration is essential as even though your business may be ready to expand, sometimes the time just may not be right. Also, these external parameters usually do have a direct impact on raw materials availability and other factors in the supply chain funnel too.

Short term analysis

Short term demand forecasting is basically to understand the demand for your goods or services in the next three to twelve months. Knowing the short term demand helps in managing the supply chain on an almost real-time basis. Also, the data here is adjusted according to the existing sales data. Short term demand estimation helps especially for those products whose line-up keeps changing. For most organisations, the short term demand does not suffice and long term demand forecasting is needed to be conducted.

Long term analysis

Long term analysis will help in estimating the demand for your product or service in the long run. Usually, the period here is anywhere between one to five years. The forecasting here helps in modelling the growth of your business. Sales data and market research being the parameters, long term forecasts may not always go exactly as predicted. This is because there may be several external factors that may impact one or both the variables. However, still, long term demand forecasting is needed as it acts as a roadmap of where your business wants to be in the long haul. The demand that is forecasted in the long haul impacts the sales, supply, funding and marketing decisions. For a growing business, it is important to plan for the future and be prepared accordingly.

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Long term demand forecasting is needed as it acts as a roadmap of where your business wants to be in the long haul.

The different methods of demand forecasting

There are several ways to derive the estimated demand for your product/service. The popular five are listed below –

Market research

The data that is collected via consumer surveys form the basis of market research demand forecasting. It is quite insightful but time-consuming well as surveys are needed to be created and distributed. However, the information you receive here is directly from your consumer or potential consumer and hence, it is of great importance. Some companies conduct market research on a continual basis while others prefer to do it only during research. It gives you a clear picture of your consumer and based on their demographics, marketing strategies can also be enhanced along with understanding their demand.

Delphi technique

The Delphi technique leverages the opinions of experts on your demand forecasting. In this method, you engage with experts outside of your organisation to understand your market forecast better and get their views on it. Usually, a questionnaire is sent to a group of demand forecasting experts. The responses of the experts are shared anonymously via a panel discussion. The process continues and answers are shared by experts in one round after the other. The answers shared in the previous panels impact the answers of the next round. This continues till the entire group of experts have come to a mutual conclusion.

The method though may sound quite extensive, it helps in understanding the views of experts on your business and its demand. Also, the reason behind the anonymity during the questionnaire helps in understanding the true views of the panels of experts. As the rounds proceed the group builds on each other’s expertise and opinions till they all arrive on the same page.

Trend projection

Trend projection is a simple and hassle-free way of demand forecasting. It basically used the trends of the past to understand and estimate the trends of the future. The data of the past sales of your product or service will be used to estimate the demand for your product/service in the future. However, it is necessary to take into account that if your sales were drastically down or up in a given period, that situation is unlikely to repat. For example, if you sell sanitizers and your sales were soaring high at the beginning of the pandemic, those high numbers are unlikely to stay the same forever. It is essential to observe and adjust any unusual factors that may have impacted your sales in the past.

Sales force composite

This is where the sales team takes the lead. In sales force composite demand forecasting, the data received from the sales team is used to understand and estimate consumer demand. This is because the sales team is usually closely connected to the consumers and may know how the consumers are feeling about your product/service. They take feedback and get requests every day from the customers and hence, they might know what is working and what is not. The sales division conducts meetings to collect the data from their team and develop a forecast accordingly.

Econometric

The econometric method as the word suggests is when you take economic factors into consideration while forecasting demand. Along with the external macro factors, even internal sales data is taken into account for predicting the demand. This method involves a lot of numbers as a mathematical formula is used for estimating the consumer demand in future. It reflects how the internal and external factors impact each other while estimating demand.

Demand forecasting is a great tool for your business as knowing the probable demand in future will help you in taking the right business decisions in the present. It is like a road map for your business. The mere demand for your product impacts its sales which impacts your profit which in turn impacts the growth and sustainability of your business.

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