The definition of demand forecasting is exactly how it sounds, it refers to the process of using historical sales data to build an estimate of an expected forecast of customer demand. The purpose of demand forecasting is to provide your company with an estimate of the amount of services or goods that customers will purchase in the foreseeable future.
There’s a ton of data points and insights you can get with your POS Data, something we do here at Accelerated Analytics daily, which is helping companies with their POS Reports and EDI 852. These reports play a vital role in forecasting, not just forecasting inventory but also forecasting demand.
As it pertains to customer demand, there’s many other factors that influence it, such as cash flow, profit margins, turnover, risk assessment, capacity planning and mitigation plans. All of these are dependent on demand forecasting, so each plays a vital role in accurate forecast.
Demand Forecasting Types
Now, there’s different types of demand forecasting, it’s important to know each type and what it represents. Each one is classified based on the level of detail, time span considered and the scope of the market being forecasted. Let’s look at few.
Outlined below are the major types of Demand Forecasting:
- Passive Demand Forecasting: Passive Demand Forecasting is used for companies that have a solid foundation but have growth plans that are on the conservative side. Simple extrapolations of historical data is carried out with minimal assumptions. This type of forecasting is rarely used, often limited to small and local businesses.
- Active Demand Forecasting: Active Demand Forecasting is used for scaling and diversifying businesses that have 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 used for short term periods (usually 3-12 month periods.) When you’re using short terms, you have to take into consideration seasonal patterns of demand and the effect of tactical decisions on the customer demand.
- Medium/Long-Term Demand Forecasting: Medium/Long-Term Demand Forecasting are usually used for 12-24 month periods in advance (some businesses use 36-48 months). Long-term Forecasting will drive a company’s strategic planning, marketing and sales planning, financial planning, capacity planning, capital expenditure, etc.
- External Macro Level Demand Forecasting: This type of Forecasting focuses on broader market movements, which depends on the macroeconomic environment. External Forecasting are built for evaluating strategic objectives of a business, this could include expanding product portfolio, penetrating new customer segments, technological disruptions, even paradigm shifts in consumer behavior and risk mitigation strategy.
- Internal Business Level Demand Forecasting: Just as the name would suggest, this type of forecasting focuses on the internal operations of the business. This could include product categories, sales division, financial division or manufacturing. Some of the internal forecast include yearly sales forecast, net profit margins, estimation of COGS, cash flow and others.
Demand Forecasting Examples
There’s a number of different demand forecasting examples we can use, so we want to give you a few to walk away with. We’ll use Ford as an example. Ford wants to build a demand forecast on their Mustang 5.0 V8 for 2018. What do they do? They would look at the last 12 months of sales for this specific vehicle. They can use this data to forecast sales for the next 12 months, plus what they need for inventory and production. They can break sales down into each package, into category as needed. If they need to know how many 2018 Mustangs were yellow, they know. Likewise, they know the sales on each package they offer, as well as all the other accessories they offer customers.
A leading clothing company refers to the last 24 months of actual sales of a very popular women’s denim jeans. An analysis is carried out to look at a particular pair of jeans to build a demand forecast. Based on the market potential of the jeans, demand is forecasted for the next 12 to 24 months. The clothing company is tracking every product, every category, every size, color, design, etc.
Importance of Demand Forecasting
As you’re now learning, demand forecasting is a 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 can be developed.
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 planning business expansions.
Demand Forecasting Methods
One of the most critical steps of the demand forecasting process is selecting the appropriate demand forecasting model to use. There’s 2 methods that can be used to forecast demand, those are known as (A) Qualitative Methods or (B) Quantitative Methods. Within each type, there’s 3 different methods, we’ll explain these below.
3 Qualitative Methods:
- The Delphi Technique: With the delphi technique, an expert panel is appointed to build a demand forecast. Each expert in the group will be asked to generate a forecast of their specific assigned segment. Once the initial forecasting round is complete, each expert will read out their forecast and provide their findings. Each expert is influenced by the other, the panel discussing each answer and the “why” behind the solutions given. Once everyone has made their case, they will do a new forecast and will continue to do so until everyone is in agreement.
- Sales Force Opinion: With the sales force opinion method, the sales manager asks for inputs of expected demand from each member of the sales team. Each salesperson will begin to evaluate their respective region, product categories and once done, they will give their customer demand report. Once finished, the sales manager aggregates all the demands and builds the final version of demand forecast after management’s judgment.
- Market Research: With this market research technique, customer-specific surveys are used 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.
3 Quantitative Methods:
- Trend Projection Method: The trend projection method can be used for companies that have a lot of sales data history, typically you want at least 18 to 24 months of sales data. Historical sales data gives you a “time stamp” which shows you all of your past sales. You’ll also have your projected demand forecast for a specific product categories you can also utilize.
- Barometric Technique: Barometric technique of demand forecasting is based on the principle of recording events in the present to predict the future. With this demand forecasting process, this can be accomplished by analyzing economic indicators. Most commonly, forecasters deploy statistical analysis like leading series, concurrent series or lagging series to build a Demand Forecast.
- Econometric Forecasting Technique: Econometric forecasting utilizes autoregressive integrated moving-average and complex mathematical equations to help establish relationships between demand and factors that influence demand. An equation is gathered and fine-tuned to ensure a reliable historical representation. FLastly, projected values of the influencing variables are inserted into the equation to generate a forecast.
Demand Forecasting Objectives
- Financial Planning
- Pricing Policy
- Manufacturing Policy
- Sales Planning
- Marketing Planning
- Capacity Planning And Expansion
- Manpower Planning
- Capital Expenditure
Demand Forecasting Models
Some companies prefer to use their own demand forecasting model, which can include all the different factors a business wants to consider when forecasting demand. Most businesses will use an extension of the demand forecasting models from above or use various methods above into the equation. None the less, as you can see, there’s a wide range methods your company can use to forecast demand.