MODULE 6 : DEMAND ESTIMATION

Market opportunity analysis requires an understanding of the differences in the notions of market
potential, sales potential, sales forecast and sales quota.

Market Potential is an estimate of the possible sales of a commodity, a group of commodities, or a

service for an entire industry in a market during a stated period under ideal conditions.

A Market refers to a specific customer group in a specific geographical area.

Sales Potential refers to the portion of the market potential that a particular firm can reasonably
expect to achieve.

Thus, market potential represents the maximum possible sales for all the sellers of the good or
service under ideal conditions and sales potential reflects the maximum possible sales for an
individual firm.

The Sales Forecast is an estimate of the dollar or unit sales for a specified future period under a
proposed marketing plan or programme. The forecast may be for a specified item of merchandise or
for an entire line, for a market as a whole or for any portion of it.

A sales forecast specifies the commodity, customer group, geographic area, and time period and
includes a specific marketing plan as an essential element. If the proposed plan is changed,
predicted sales are also expected to change.

Forecast sales are typically less than the company’s sales potential.

Typically, the process begins with an assessment of the economic environment. Then, given an
initial estimate of industry potential and the company’s competitive position, the firm’s sales
potential can be estimated. This in turn leads to an initial sales forecast, often based on the
presumption that the marketing effort will be similar of what it was last year. The initial forecast is
then compared with objectives established for the proposed marketing effort. If the marketing
program is expected to achieve the objectives, both the program and the sales forecast are adopted.
If the marketing program is expected to achieve the objectives, both the programme and the sales
forecast is adopted.

The objectives may also need revising : but eventually the process should produce agreement
between the forecast or expected sales and the objectives. The sales forecast then becomes a basic
input in establishing budgets for the various functional areas.

A Sales Quota is a sales goal or objective assigned to a marketing unit. Sales quotas are typically a
key measurement used to evaluate personal selling effort. They apply to specific periods and can be
studied in great detail.

ESTIMATION OF DEMAND
Determine who uses the Product or Service
For established products, specifying important user characteristics or factors that affect use is
relatively easy because of the company’s experience and research. New products may rely on an
analogy with similar products – or it might require a survey of potential users or even a small
market test.
Determine Rate of Use
In estimating market potential, especially for major appliances and consumer durables, the firm
would probably want to estimate new demand and replacement demand, considering the expected
life of the product.

Determine Who Buys the Product or Service

Buyers and their motivation for buying will affect how much of the potential is likely to be realised.
Thus, although an individual firm might choose to direct a major portion of its promotional effort to
buyers, it might also channel a portion of that effort to users.

Determine the Market Motivations for Purchase

This involves an analysis of the reasons why a consumer may buy a particular product or various
influences that might work on prospective buyers to buy a product or service.

There are two kinds of Sales Forecasting Methods :

(i) Subjective Methods
- User’s expectations
- Sales force composite
- Jury of executive opinion
- Delphi technique

(ii) Objective Methods

- Market test
- Moving averages
- Exponential smoothing
- Decomposition
- Statistical demand analysis

(i) USER’S EXPECTATIONS OR BUYER’S EXPECTATIONS METHOD

This method relies on answers from customers regarding their expected consumption or purchases
of a product. The customers may be surveyed in person, over the telephone, by mail, or perhaps by
computer.

The responndents in a user’s expectation survey do not necessarily have to be the ultimate
consumers. Rather the firm may find it advantageous to secure the reactions of wholesalers or
retailers that serve the channel.

Advantages
- The forecast is based on estimates obtained directly from firms whose buying actions will
actually determine the sales of the product.
- The way the information is collected – projected use by the consumer – allows the
preparation of forecasts in graet detail 9by product, by customer or by sales territory)
- The method often provides insight into the buyer’s thinking and plans, which is helpful in
making the marketing strategy.
- This technique can be used when other techniques may be impossible, as when forecasting
the sales of a new product.

Disadvantages
- Potential customers must be few and well-defined
- Does not work well for consumer goods
- Depends on the accuracy of user’s estimates
- Expensive, time-consuming, labour-intensive.

(ii) SALES FORCE COMPOSITE METHOD

This method is so called because the initial input is the opinion of each member of the field sales
staff. Each person states how much he/she expects to sell during the forecast period. These
estimates are typically adjusted at various levels by sales management. They are likely to be
checked, discussed and possibly changed by the branch manager and on up the sales organisation
chart until the figures are finally accepted at corporate headquarters.

Advantages
- Involves the people (sales personnel) who will be held responsible for the results.
- Fairly accurate
- Aids in controlling and directing the sales effort
- Forecast is available for individual sales territories

Disadvantages
- Estimators (sales personnel) have a vested interest and therefore maybe boased
- Elaborate schemes sometimes necessary to counteract bias
- If estimates are biased, process to correct the data can be expensive.

(iii) JURY OF EXECUTIVE OPINION OR EXPERT OPINION METHOD

This method informally or formally polls the top executives of the company for their assessment of
sales possibilities. The separate assessments are combined into a sales forecast for the company.
Sometimes, this is done by simply averaging the individual judgements; but at other times disparate
views are resolved through group discussion. The initial views may reflect no more than the
executive’s hunch about what is going to happen or the opinion may be based on considerable
factual material, sometimes even an initial forecast prepared by other means.

Advantages
- easily done, very quick
- does not require elaborate statistics
- utilises collective wisdom of the top people
- useful for new or competitive products in absence of adequate data or previous experience

Disadvantages
- Produces aggregate forecasts that must often be broken down by product and by time to plan
production and financing
- Expensive because of the costs involved in breaking down aggregate data and the large
amounts of highly paid executives’ salaries
- Disperses responsibility for the forecasts
- Group dynamics operate

(iv) DELPHI TECHNIQUE

Delphi uses repeated measurements and controlled feedback instead of direct confrontation and
debate among the experts preparing the forecast. Each individual prepares a forecast using whatever
facts, figures, and general knowledge of the environment he or she has available. Then, the
forecasts are collected, and an anonymous summary is prepared by the person supervising the
process. The summary is distributed to each person who participated in the initial phase. Typically,
the summary lists each forecast figure, the average (median), and some summary measures of the
spread of the estimates. Often those whose initial estimates fell outside the midrange of responses
are asked to express their reasons for these extreme positions. These explanations are then
incorporated in the summary. The participants study the summary and submit the revised forecast.
The process is then repeated.

The method is based on two premises :

- the range of responses will decrease, and the estimates will converge with repeated
measurements
- the total group response or media will move successively toward the correct or the true
answer

Advantages
- minimises effect of group dynamics
- can utilise statistical information

Disadvantages
- can be expensive and time-consuming

(v) MARKET TEST

The typical market test involves placing the product in several “representative” cities to see how well it
performs and then projecting that experience to the country as a whole. Often this is done for a new product as a
whole or an improved version of the old product.

Advantages
- Provides ultimate test of consumer’s reactions to the product
- Allows the assessment of the effectiveness of the total marketing programme
- Useful for new and innovative products

Disadvantages
- Lets competitors know what the firm is doing
- Invites competitive reaction
- Expensive and time-consuming to set up
- Often takes a long time to accurately assess level of initial demand and repeat demand

(v) TIME SERIES ANALYSIS

Time series approaches to sales forecasting rely on the analysis of historical data to develop a
prediction for the future. The sophistication of these analysis can vary widely. At one extreme, the
forecaster might simply forecast next year’s sales to be equal to this year’s sales. Such a forecast
might be reasonably accurate for a mature industry that is experiencing little growth. If there is
growth however, the forecaster might allow for it by predicting the same percentage increase for
next year that the company experienced for the this year. Still further along the spectrum, the
forecaster might attempt to break historical sales into basic components by isolating that portion due
to trend, cyclical, seasonal components and irregular influences. All these components could all be
forecast separately and then combined to produce the aggregate forecast.

Advantages
- Utilises historical data
- Objective, inexpensive
Disadvantages
- not useful for new or innovative products
- factors for trend, cyclical, seasonal or product life cycle phase must be accurately assessed
and included
- Technical skill and good judgement required
- Final forecast difficult to break down into individual territory estimates
- Ignores planned marketing effort

Various types of Time Series approaches are :

(a) Moving average
(b) Exponential smoothing
(c) Decomposition methods

(a) Moving Averages

Consider the forecast that next year’s sales will be equal to this year’s sales. Such a forecast might
be subject to large error if there is much fluctuation in sales from one year to the next. To allow for
such randomness, we might consider using some kind of average recent values. The forecast would
simply be the average that resulted. The number of observations included in the average is typically
determined by trial and error. Differing number of periods are tried and the number of periods that
produces the most accurate forecasts on the trial data is used to develop the forecast model. Once
determined, it remains constant. The term moving average is used because a new average is
computed and used as a forecast as each new observation becomes available.

(b) Exponential Smoothing

The method of moving averages gives equal weight to each of the last n values in forecasting the
next value. Thus, when n = 4 (the four year moving average being used), equal weight is given to
each of the last four year’s sales in predicting the sales for next year. No weight is given to any
sales five or more years previous.

Thus, the forecasting equation is :

X t+1 = X t + X t-1 + X t-2 + X t-3

N

X t+1 = forecast value for the next year or next period

Xt = actual sales that resulted in year or period t

Exponential smoothing is a type of moving average. However, instead of weighting all observations
equally in generating the forecast, exponential smoothing weights the most recent observations
heaviest. The most recent observations contain the most information about what is likely to happen
in the future, and they should logically be given more weight. The general form of the exponential
smoothing model is :
^ ^
X t+1 = α X t + (1- α) X t

The caret sign indicates a forecast value and an X without a caret indicates an actual value. The
exponential smoothing model thus suggests next year’s sales will equal this year’s sales multiplied
by the constant plus the forcast value of this year’s sales times the constant (1- α). It can be shown
by successive substitution that the second term in licitly recognizes older values, thereby
overcoming a second limitation of the moving average method, which ignores all those values more
than “n” periods old.
The key decision affecting the use of exponential smoothing is the choice of “α” which is called the
“smoothing constant” and which is constrained to be between 0 and 1. High values of α give great
weight to recent observations and little weight to distant sales while low values of α give more
weight to older observations. Low values of α are associated with slow changes in sales while when
sales experience rapid changes in fluctuations, high values of α should be used so that the forecast
responds to these changes quickly. This value is normally determined empirically – various values
are tried and the one that produces the smallest error when applied to the historical sales is adopted.

© Decomposition
The decomposition method of sales forecasting is typically applied to monthly or quarterly data
where a seasonal pattern is evident and the manager wishes to forecast sales not only for the year
but also for each period in the year.

The decomposition method attempts to isolate four separate portions of a time series :
- the trend
- cyclical
- seasonal
- random factors

- the trend reflects the long run changes experienced in the series when the cyclical, seasonal,
and irregular components are removed. It is typically assumed to be a straight line.

- The cyclical factor is not always present because it reflects the waves in a series when the
seasonal and irregular components are removed. These fluctuations typically occur over a
long period – perhaps two to long years and may also vary for different products.

- The seasonal factor reflects the annual fluctuation in the series due to the natural reasons. It
normally repeats itself each year, although the expected pattern of sales maybe different
each year.

- The random factor is what is left after the influence of the trend, cyclical and seasonal
influences are removed.

In using the decomposition method, the analyst typically first determines the seasonal pattern and
removes its impact to identify the trend. Then the cyclical factor is estimated. After the three
components are isolated, the forecast is developed by applying each factor in turn to the historical
data.

Advantages
- provides a systematic means for making quantitative projections of sales – and this is both
its major advantage and disadvantage.
- The method is objective in that two analysts working on the same data series using the same
forecasting technique should produce the same forecast. This is not necessarily true with the
subjective methods discussed earlier.
- Allows the forecaster to take advantage of the repetitive patterns exhibited by the historical
sales.
-

Disadvantages
- conditions change and may not correspond to historical data. Even the most regular sales
series are likely to vary because of changes in the economic environment, technology, or
competition.
- Difficult or impossible to use when the series is very irregular because of aberrations
included by external shocks.
- Requires good deal of technical skill and judgement, depending on the type of time series
forecasting method used
- Hard to break down the forecasts into estimates for individual salespeople and territories.

(vi) STATISTICAL DEMAND ANALYSIS

Time series analysis attempts to determine the relationship between sales and time as the basis of
the forecast for the future. Statistical demand analysis attempts to determine the relationship
between sales and the important factors affecting sales to forecast the future.Typically, regression
analysis is used to estimate the relationship. The emphasis is not to isolate all factors that affect
sales but simply to identify those that have the most dramatic impact and then to estimate the
magnitude of the impact. Sometimes firms attempt to relate their sales to one or more aggregate
indicators of economic activity.

Advantages
- Great intuitive appeal as it involves accurate identification of the major forces that affect
sales
- Requires quantification of assumptions underlying the estimates
- Allows management to check results
- Uncovers hidden factors affecting sales
- Method is objective

Disadvantages
- Factors affecting sales must remain constant and be accurately identified to produce an
accurate estimate
- Requires technical skill and expertise Some managers are reluctant to use this method due to
its sophistication.

CHOOSING A FORECASTING METHOD

In a typical company, the decision is more likely to depend on:
- its level of technical sophistication and the existence of historical sales data.
- likely depend on the use to which the forecast will be put
- Another guide that managers could use is what other companies have done.

What Companies Use

The most popular methods emphasis heavier reliance on the subjective methods versus quantitative,
objective methods. The sales force composite method and the jury of executive opinion seem
particularlt popular. There are a lot of benefits to be gained from involving line people in the
forecasting process.
The process of forecasting is stimulating to the committeemen (the company’s forecasting
committee) who participate. It forces them to think ahead, to evaluate opportunities for improving
performance, and to mesh plans in a coordinated way. These things are more important than the
accuracy of the figures that emerge from the process.

Accuracy
In general, the various forecast comparisons suggest that no method is likely to be superior under all
conditions. However, the following are a few basic guidelines :
- A technique that works well for one series may not work on another. The quantitative
approaches seem to do best where the database is rich with observations and not subject to
major changes. The subjective methods seem to work best when the forecast is long term,
infrequent, and hard to correct, and where the database is skimpy but forecast errors are
likely to cause large losses. The choice of technique should depend partially on the use of
the forecast and the consequences if it is in error.
- More accurate forecasts can be generated by combining forecasts developed from different
techniques, than can be generated by searching for the one best technique.
- Forecast accuracy can be overemphasized. Forecasts are usually constructed on the
assumption that tomorrow’s world will be much like todays. However, sooner or later the
forecasts will fail when they are needed the most, in anticipating major shifts in the business
environment that make the whole strategies obsolete.

To cope with revolutionary changes that can especially affect the business and to better understand
the critical sensitivities of the business, firms are increasingly turning to scenario planning.

Scenario planning involves asking those preparing the forecast a series of “what if” questions,
where the “what if” reflects different environmental changes that could occur. Some very unlikely
changes are considered along with more probable events. The key idea is not so much to have one
scenario that “gets it right” as to have a set of scenarios that illuminate the major forces driving the
system, their interrelationships and the critical uncertainties.

DEVELOPING TERRITORY ESTIMATES

- Territory estimates recognise the condition that the potential for any product may not be
uniform by area. Awareness of the differences in territory demand allows the firm to do a
better job in designing the market strategy. These estimates are particularly important to the
sales manager who must deal with a geographically dispersed sales force.

Territory demand estimates allow more effective planning, directing and controlling of salespeople
in that the estimates affect the following :
- the design of sales territories
- the procedures used to identify potential customers
- the establishment of sales quotas
- compensation levels and the mix of components in the firm’s slaes compensation scheme
- the evaluation of salespeople’s performance

How can territory estimates be derived?

- Some of the sales forecasting schemes provide them naturally.
- A survey of users or salespeople provides detailed estimates of demand, often by product by
customer. These estimates can easily be combined into larger aggregates to produce demand
estimates by product by territory.
- The use of sales history of a particular product in a particular territory in, say, a time series
approach produces a forecast with the desired geographic detail.
- The jury of executive opinion and the statistical demand analysis produces aggregate
estimates that have to be apportioned to areas.

The use of market factors or market indexes is the basic way aggregate estimates of demand are
broken down by territory.

A Market factor is a feature or characteristic in a market that is related to the demand for the
product.
A Market index is a mathematical expression that combines two or more market factors into a
numerical index. Typically, this would be done by forming a linear combination of the forces where
the weights assigned to each factor would reflect their expected relative importance in affecting the
demand for a product. The amount of total demand apportioned to a territory would reflect the
relative size of the index versus the national total. Typically, this means treating the national total as
100 percent and assessing the portion of it that lies within the geographical boundaries being
considered.

Industrial Goods
Territorial demand estimates for industrial are typically developed by relating sales to some
common denominator. The common denominator or market factor might be the total number of
employees, number of production employees, value added by manufacturer, value of materials
consumed, value of products shipped, or expenditures for new plant and equipment.

The identifiable markets are usually defined using codes such as employment, value added in
manufacturing, capital expenditures and total sales.

An advantage of a market factor such as number of employees or square feet for breaking down
total demand is that territory demand is derived objectively. The assumptions and calculations are
obvious, and managers can readily follow the development of the estimates. Furthermore, the
assumptions can be varied in systematic ways, and the impact on estimated demand can be
calculated. The method allows the calculation of not only area potentials but also customer
potentials if the firm wishes to put the calculations so far. This is the primary reason why sellers of
industrial goods base their calculations on SIC codes.

Consumer Goods
Sellers of consumer goods are more apt to rely on aggregate conditions in each territory. Sometimes
this will be a single variable or market factor like the number of households, population, or perhaps
the level of income in the area. In other instances, the firm attempts to relate demand to several
variables combined in a systematic way.

One of the most standard indexes is the Buying Power Index (BPI). This index considers income,
population, and retail sales. These are weighted by the factors 5, 2, and 3 respectively, to generate a
single number for a geographic region. This number is used to estimate the share of total market
demand in the area.

The BPI of an area can be calculated using the formula :

BPI = 5I + 2P + 3R
10

where I is the percentage of disposable personal income in the area

P is the percentage of the population
R is the percentage of total retail sales

BPI is not very useful in estimating territory potentials for industrial products. Nor is it useful for
infrequently purchased, high-priced goods. It is very popular though, when estimating territory
potential for frequently purchased, lower-priced convenience goods.
One strategy for a firm selling consumer goods is to determine empirically if the BPI correlates with
the industry sales by area. If the index does not correlate with sales of the product, then the firm is
better off :
- using a single market factor
- - developing its own index using factors logically related to sales and some a priori or
empirically determined weights regarding their relative importance, rather than by blindly
using the BPI to develop territory demand estimates.