PROJECT ENGINEERING AND ECONOMICS

SEMINAR

DEMAND FORECASTING, UNCERTAINITIES OF DEMAND

FORECASTING AND MARKET PLANNING

GROUP 12 : ROLL NUMBER 4,13,17,19,28,42

DEMAND FORECASTING

INTRODUCTIONThe prediction of probable demand for a product or a service

on the basis of the past events and prevailing trends in the present is called DEMAND FORECASTING

Demand forecasting may be used in production planning, inventory management, and at times in assessing future capacity requirements, or in making decisions on whether to enter a new market.

Demand forecasting involves techniques including both informal methods, such as educated guesses, and quantitative methods, such as the use of historical sales data and statistical techniques or current data from test markets.

OBJECTIVES OF DEMAND FORECASTING

The objectives of demand forecasting are different in case of short run and long run forecasts.

• SHORT RUN FORECASTING : A period not exceeding one year. Objectives :

1. To evolve a suitable production policy

2. To plan the purchase of raw materials

3. To plan short term financial requirements

4. To determine appropriate price policy

5. To fix sales targets

• LONG RUN FORECASTING : A period lasting more than 3 years

OBJECTIVES :

1. Expansion of new unit or construction of new unit

2. To plan long term financial requirements

3. To plan Man power requirements

HOW IS DEMAND FORECAST DETERMINED ?

DESCRIPTION QUALITATIVE APPROACH QUANTITATIVE APPROACH

Applicability Used when situation is vague & little data exist (e.g., new products and technologies)

Used when situation is stable & historical data exist(e.g. existing products, current technology)

Considerations Involves intuition and experience

Involves mathematical techniques

Techniques 1.Jury of executive opinion2.Sales force composite3.Delphi method4.Consumer market survey

1.Time series models2.Causal models

QUALITATIVE FORECASTING METHODSQualitative

MethodDescription

Jury of executive opinion

The opinions of a small group of high-level managers are pooled and together they estimate demand. The group uses their managerial experience, and in some cases, combines the results of statistical models.

Sales force composite

Each salesperson (for example for a territorial coverage) is asked to project their sales. Since the salesperson is the one closest to the marketplace, he has the capacity to know what the customer wants. These projections are then combined at the municipal, provincial and regional levels.

Delphi method A panel of experts is identified where an expert could be a decision maker, an ordinary employee, or an industry expert. Each of them will be asked individually for their estimate of the demand. An iterative process is conducted until the experts have reached a consensus.

Consumer market survey

The customers are asked about their purchasing plans and their projected buying behaviour. A large number of respondents is needed here to be able to generalize certain results.

QUANTITATIVE FORECASTING METHOD

There are two forecasting models here –

(1) THE TIME SERIES MODEL :. A time series is a s et of evenly spaced numerical data and is obtained by observing responses at regular time periods. In the time series model , the forecast is based only on past values and assumes that factors that influence the past, the present and the future sales of your products will continue.

(2) THE CAUSAL MODEL: causal model uses a mathematical technique known as the regression analysis that relates a dependent variable (for example, demand) to an independent variable (for example, price, advertisement, etc.) in the form of a linear equation.

TIME SERIES METHOD1. MOVING AVERAGE METHOD : MA is a series of arithmetic means and is used if little

or no trend is present in the data; provides an overall impression of data over time. A simple moving average uses average demand for a fixed sequence of periods and is good for stable demand with no pronounced behavioural patterns.

St-1 + ….. + St-n+1

n

F – Forecast S – Sales n – Period t – time of forecast

YEAR SALES FORECAST (3’P) FORECAST (5’P)

2001 28

2002 29

2003 28. 5

2004 31.0 (28+29+28.5)/3 = 28.5

2005 34.2 (31+28.5+29)/3 = 29.5

2006 32.7 (34.2+31+28.5)/3 = 31.23 (34.2+31+28.5+29+28)/5 = 30.14

2. TREND PROJECTION METHOD : The Trend Projection Method is the most classical method of business forecasting, which is concerned with the movement of variables through time. This method requires a long time-series data. The trend projection method is based on the assumption that the factors liable for the past trends in the variables to be projected shall continue to play their role in the future in the same manner and to the same extent as they did in the past while determining the variable’s magnitude and direction.

The trend projection method includes three techniques based on the time-series data : (a) Graphical Method (b) Least Square Method (c ) Box Jenkins MethodThe analyst chooses a plausible algebraic relation (linear, quadratic, logarithmic, etc.) between sales. And the independent variable, time. The trend line is then projected into the future by extrapolation.This method is popular because it is simple and inexpensive. The basic assumption is that the past rate of change will continue in the future. Thus the techinique yields acceptable results so long as the time series shows a persistent tendency to move in the same direction.

Estimation of Trend by the Method of Least Squares The annual sales of a company are as follows:

Year 1991 1992 1993 1994 1995Sales ‘000 45 56 58 46 75

Using the method of least squares, fit a st. line trend and estimate the annual sales of 1997.

Year Sales

y

1990 = 0Time-

Deviationx

x2 xy Estimated Trend’000Y=45 + 5x

1991 45 1 1 45 501992 56 2 4 112 55

1993 78 3 9 234 60

1994 46 4 16 184 65

1995 75 5 25 375 70

n = 5 y = 300 x = 15 x2 = 55 xy = 950

n = 5 y = 300 x = 15 x2 = 55 xy = 950

y = n.a. + b x …1xy = a x + b x2 …. 2

Substituting the computed valueswe have,300 = 5a + 15b ….3 (x 3)950 = 15a + 55b …. 4Multiplying (3) by 3 we have900 = 15a + 45b950 = 15a + 55b Therefore, 10b = 50, b = 5Substituting b = 5 in (3)300 = 5a + 15(5)300 = 5a + 755a = 225 a = 45

St. line equation is Y = a + bxSubstituting the values of a and b,Y = 45 + 5xTherefore,Y1991 (x=1) = 45 + 5(1) = 50Y1992 (x=2) = 45 + 5(2) = 55Y1993 (x=3) = 45 + 5(3) = 60Y1994 (x=4) = 45 + 5(4) = 65Y1995 (x=5) = 45 + 5(5) = 70Y1996 (x=6) = 45 + 5(6) = 75Forecast for the year 1997Y1997 (x=7) = 45 + 5(7) = 80i.e. Rs.80,000/-

3. EXPONENTIAL SMOOTHING : In this method, forecast are modified on account of errors . It is an easily learned and easily applied procedure for approximately calculating or recalling some value, or for making some determination based on prior assumptions by the user, such as seasonality.

Ft – Forecast for period ‘t’

Dt – Actual demand for period ‘t’

Error = Dt – Ft

a - Smoothing Parameter which usually lies between 0 and 1

Ft+1 = Ft + a (error) = Ft + a (Dt – Ft)

EXPONENTIAL SMOOTHING : EXAMPLE

CASUAL METHOD :Forecast on the basis of cause and effect relationships that are expressed quantitatively. Some of the important methods are:

1. CHAIN RATIO METHOD: This method applies a series of factors to determine the demand.

2. CONSUMPTION LEVEL METHOD: This method is used for those products that are directly consumed. This method measures the consumption level on the basis of elasticity coefficients.

The important ones are :

• Income Elasticity: This reflects the responsiveness of demand to variations in income. It is calculated as:

Where

E1 = Income elasticity of demand

Q1 = quantity demanded in the base year

Q2 = quantity demanded in the following year

I1 = income level in the base year

I2 = income level in the following year

E1 = [Q2 - Q1/ I2- I1] * [I1+I2/ Q2 +Q1]

• Price Elasticity: This reflects the responsiveness of demand to variations in price. It is calculated as:

  Where EP   = Price elasticity of demand   Q1  = quantity demanded in the base year           Q2  = quantity demanded in the following year           P1     = price level in the base year       

             P2   = price level in the following year

3. END USE METHOD: This method forecasts the demand based on the consumption coefficient of the various uses of the product.

4. LEADING INDICATOR METHOD: This method uses the changes in the leading indicators to predict the changes in the lagging indicators.

5. ECONOMETRIC METHOD: An advanced forecasting tool, it is a mathematical expression of economic relationships derived from economic theory.

EP = [Q2 - Q1/ P2- P1] * [P1+P2/ Q2 +Q1]

UNCERTAINITIES OF DEMAND FORECASTINGDemand forecasts are subject to error and uncertainty which arise from three different sources:

Ø DATA ABOUT PAST AND PRESENT MARKET : The analysis of past and present markets, which serve as the springboard for the projection exercise, may be vitiated by the following inadequacies of data:

1. Lack of Standardization: Data pertaining to market features like product, price, quantity, cost, income, etc. may not reflect uniform concepts and measures.

2. Few observations: observations available to conduct meaningful analysis may not be enough.

3. Influence of abnormal factors: Some of the observations may be influenced by abnormal factors like war or natural calamity.

Ø METHODS OF FORECASTING : Methods used for demand forecasting are characterized by the following limitations:

4. Inability to handle unquantifiable factors: most of the forecasting methods, being quantitative in nature, cannot handle unquantifiable factors which sometimes can be of immense significance.

5. Unrealistic assumptions: Each forecasting method is based on certain assumptions. For example, the trend projection method is based on the mutually compensating affects premise and the end use method is based on the constancy of technical coefficients. Uncertainty arises when the assumptions underline the chosen method tend to be realistic and erroneous.

6. Exercise data requirement: In general, the more advanced a method, the greater the data requirement. For example, to use an econometric model one has to forecast the future values of explanatory variables in order to project the explained variable.

Ø ENVIRONMENTAL CHANGES: The environment in which a business functions is characterized by numerous uncertainties. The important sources of uncertainty are mentioned below:

• Technological Change: This is a very important and very hard-to-predict factor which influences business prospects. A technological advancement may create a new product which performs the same function more efficiently and economically, thereby cutting into the market for the existing product. For example, electronic watches are encroaching on the market for mechanical watches.

• Shift in Government Policy: Government resolution of business may be extensive. Changes in government policy, which may be difficult to anticipate, could have a telling effect on the business environment.

• Development on the International Scene: Development on the International Scene may have a profound effect on industries.

• Discovery of New Sources of Raw Material: Discovery of new sources of raw materials, particularly hydrocarbons, can have a significant effect on the market situation of several products.

• Vagaries of Monsoon: Monsoon, if plays an important role in the economy of a country, is somewhat unpredictable. The behaviour of monsoon influences, directly or indirectly, the demand for a wide range of products.

COPING WITH UNCERTAINITIES

Given the uncertainties in demand forecasting, adequate efforts, along the following lines, may be made to cope with uncertainties.

Ø Conduct analysis with data based on uniform and standard definitions.

Ø In identifying trends, coefficients, and relationships, ignore the abnormal and out-of-the-ordinary observations.

Ø Critically evaluate the assumptions of the forecasting methods and choose a method which is appropriate to situation.

Ø Adjust the projections derived from quantitative analysis in the light of unquantifiable, but significant, influences.

Ø Monitor the environment imaginatively to identify important changes.

Ø Consider likely alternative scenarios and their impact on market and competition.

Ø Conduct sensitivity analysis to access the impact on the size of demand for unfavourable and favourable variations of the determining factors from their most likely levels.

MARKET PLANNING

SITUATIONAL ANALYSIS : SWOT ANALYSIS

SWOT ANALYSIS focuses on Strengths, Weaknesses, Opportunities and Threats as the key drivers or inhibitors of any business. To ensure this format helps inform meaningful interpretation and conclusions, the information you use should be as accurate as possible. • STRENGTHS AND WEAKNESS are critical factors to the effectiveness and

success of a business. Most often these are internal to the business and are elements that a business can control. They can be either actual or perceived i.e. level of distribution is actual while brand image is perceived. In marketing terms, actual and perceived factors can be equally important and their relative merits should be assessed within the overall analysis. Examples of strengths would include high brand awareness, good reputation for quality, good service levels, high margins or unique product positioning. Weaknesses would include unsatisfactory product delivery, poor relationship between price and quality, lack of unique selling point, low investment in marketing or weak internal cost control. Promoting strengths can be an effective strategy for growth and can lead to improved competitive advantage. Equally, redressing a weakness puts the business in a stronger position to capitalise on the effect of its marketing activity.

• OPPORTUNITIES AND THREATS are external and, therefore, more out with the control of the business. They can arise from competitive activity, channel pressure, demographic changes, political, technological or legislative developments. Understanding and pre-empting these external factors is key to building strategy. For example, the ageing population and rise of out-of-home eating are two major changes, which will impact on food expenditure in the coming decades. The implications of these should be considered within the overall company strategy in term of e.g. product range, distribution channels, and product delivery. Identifying opportunities and threats can focus strategic planning both in the short and long term. Well informed, creative forward planning is a key business advantage and can lead to innovation far beyond the company’s apparent capabilities.

SWOT ANALYSIS EXAMPLE

1. STRENGTHS• Knowledge. Our competitors are retailers, pushing boxes. We know systems, networks,

connectivity, programming, all the Value Added Resellers (VARs), and data management.• Relationship selling. We get to know our customers, one by one. Our direct sales force

maintains a relationship.• History. We’ve been in our town forever. We have the loyalty of customers and vendors.

We are local.

2. WEAKNESSES• Costs. The chain stores have better economics. Their per-unit costs of selling are quite

low. They aren’t offering what we offer in terms of knowledgeable selling, but their cost per square foot and per dollar of sales are much lower.

• Price and volume. The major stores pushing boxes can afford to sell for less. Their component costs are less and they benefit from volume buying with the main vendors.

• Brand power. Take one look at their full-page advertising, in color, in the Sunday paper. We can’t match that. We don’t have the national name that flows into national advertising.

AMT is a computer store in a medium-sized market in the United States. Lately it has suffered through a steady business decline, caused mainly by increasing competition from larger office products stores with national brand names. The following is the SWOT analysis included in its marketing plan.

3. OPPORTUNITIES

• Local area networks. LANs are becoming commonplace in small businesses, and even in home offices. Businesses today assume LANs are part of normal office work. This is an opportunity for us because LANs are much more knowledge and service intensive than the standard off-the-shelf PC.

• The Internet. The increasing opportunities of the Internet offer us another area of strength in comparison to the box-on-the-shelf major chain stores. Our customers want more help with the Internet and we are in a better position to give it to them.

• Training. The major stores don’t provide training, but as systems become more complicated with LAN and Internet usage, training is more in demand. This is particularly true of our main target markets.

• Service. As our target market needs more service, our competitors are less likely than ever to provide it. Their business model doesn’t include service, just selling the boxes.

4. THREATS

• The computer as appliance. Volume buying and selling of computers as products in boxes, supposedly not needing support, training, connectivity services, etc. As people think of the computer in those terms, they think they need our service orientation less.

• The larger price-oriented store. When they have huge advertisements of low prices in the newspaper, our customers think we are not giving them good value.

BREAK EVEN ANALYSISBreakeven analysis is used to determine when your business will be able to cover all its expenses and begin to make a profit. It is important to identify your startup costs, which will help you determine your sales revenue needed to pay ongoing business expenses.EXAMPLE : If you have $5,000 of product sales, this will not cover $5,000 in monthly overhead expenses. The cost of selling $5,000 in retail goods could easily be $3,000 at the wholesale price, so the $5,000 in sales revenue only provides $2,000 in gross profit. The breakeven point is reached when revenue equals all business costs.To calculate your breakeven point, you will need to identify your fixed and variable costs. • Fixed costs are expenses that do not vary with sales volume, such as rent

and administrative salaries. These expenses must be paid regardless of sales, and are often referred to as overhead costs.

• Variable costs fluctuate directly with sales volume, such as purchasing inventory, shipping, and manufacturing a product.

To determine your breakeven point, use the equation below:

Break even point = fixed costs/ (unit selling price – variable costs)

MARKETING STRATEGY : 5 PS OF MARKETING

Market Planning

PRICING

PROMOTION

PLACE OR CHANNEL OF

DISTRIBUTIONPEOPLE

PRODUCT

TERMINOLOGIES RELATED TO PRICING

• EX-FACTORY PRICE : Ex-factory price refers to the cost a manufacturer charges for a distributor or other buyer to purchase products directly from the source. This is a quote for the goods alone. It does not include shipping, handling or taxes. This practice is common when working with raw materials for secondary manufacturing.

• TAXES AND DUTIES : a duty is a kind of tax levied by a state. It is often associated with customs, in which context they are also known as tariffs or dues. The term is often used to describe a tax on certain items purchased abroad.

• TRADE MARGINS :A trade margin is the difference between the actual or imputed price realised on a good purchased for resale (either wholesale or retail) and the price that would have to be paid by the distributor to replace the good at the time it is sold or otherwise disposed of.

• DISCOUNTS : Reduction of cost price of the product

• EXPORT PRICE : Price fixed for the export products or services which the exporter intends to sell in the overseas market is called export pricing.

PRICING TECHNIQUESa. Cost – Plus Method – it is the simplest method. The cost of the product

is figured out and tacked on a little something for profit.

b. Market-Oriented Method - this is not based on cost, but on the interaction of demand and supply,

c. “Loss” Leader Strategy - Some products may be sold at a losing preposition to attract customers to go to their stores. The mark-up is taken from other products.

d. Psychological Pricing – Stating the price on a lower scale.

e. Value for Money Pricing – this pricing approach is not aimed at maximizing profit per single purchase but in bulk of quantity/frequent sale. This sales tactic is an ideal mechanism in tapping potential sales through more purchases, thus clearing inventory gluts and crating an image of fresh supply. This pricing concept targets either or both the diet and price conscious consumers.

f. Pricing Factor Segmentation – the “seller” subdivides the market into groups responsive to price and price deals, product quality,etc.

Ex. No left-over, No sharing buffets – 50%

Discount per pack

50% Discounts on all products at 8:45p.m. everyday

This strategy favors both the consumer and the seller. On the part of the consumers, they get the benefit of quality and good tasting products at reduced prices. On the other hand, the seller avoids wastage and minimizes cost of storage.

g. Marked Down Pricing – in cases where demand is limited and competition is intense, the usual mark-up pricing approach is temporarily suspended in favor of a markdown to capture a segment of the market. The concept behind the markdown pricing is the “thought” that the lower you can make your price, the more you sell, and you generate revenues sufficient to cover costs and provide a profit.

h. Bonus-Pack Pricing – for the end-users, this is commonly used so that they will buy more than the required quantity. A good example is the :

“Buy 34 at the price of 30