Four Steps to Forecast Total Demand – by F. William Barnett

·         In recent history, many companies have made serious strategic errors because of inaccurate industry wide demand forecasts.  During the 70’s and 80’s, U.S. electric utilities, the petroleum industry, and PC manufactures suffered serious financial harm because of investments in markets where growth and demand was over-projected.
·         The big mistake these companies made was they relied on the mistaken fundamental assumption that relationships driving demand in the past would continue unaltered.  The companies failed to foresee changes in end-user behavior or to understand their market’s saturation point.  History can be an unreliable guide for forecasting market demand given the emerging global economy, rapid technological innovation, and the evolution of industries.
·         By gauging total market demand explicitly, you have a better chance of controlling your company’s destiny.
·         There are four steps to total market forecast:
o    Define the market.
o    Divide total industry demand into its main components.
o    Forecast the drivers of demand in each segment and project how they are likely to change.
o    Conduct sensitivity analyses to understand the most critical assumptions and to gauge risks to the baseline forecast.
·         Defining the Market:
o    At first, it’s best to be overly inclusive, so define the market broadly enough to include all potential end users so that you can both identify the appropriate drivers of demand and reduce the risk of surprise product substitutions.
o    It is critical to understand product substitution in the market.  Be aware of how customer behavior may change if the price or performance of potential substitute products changes.  Be aware that a completely new product could displace a product (i.e. the calculator eliminated the slide rule).
o    How do you make sure you have included all important substitute products?:
§  Interviews with industrial customers
§  Market research about consumer products
§  Talk with experts in the relevant technologies
§  Review technological literature
§  Quantify the economic value of alternative products to different customers in order to gain insight into potential switching behavior
o    These analyses can lead to the construction of industry demand curves which represent the relationship between price and volume.
·         Dividing Demand into Component Parts:
o    Make each category small and homogenous enough so that the drivers of demand will apply consistently across its various elements, but also make each large enough so that the analysis will be worth the effort.
o    Outline alternative segmentations based, for example, on end-use customer groups or type of purchase.
o    In thinking about market divisions, managers need to decide whether use existing data on segment sized or to commission research to get an independent estimate.
o    Be wary that while this type of segmentation may be sufficient for forecasting total demand, it may not create categories useful for developing a marketing strategy.
·         Forecasting the Drivers of Demand:
o    Obvious tools for this step are regression and other statistical techniques to find some causes for changes in historical demand.
o    However, you must also look at factors where data are harder to find.
o    Demand is almost always affected by both macroeconomic variables and by industry-specific developments, i.e. shifts in the demand or supply curves, economic growth.
o    Knowing the drivers of demand is crucial to the success of any total market demand forecast.
·         Conducting Sensitivity Analysis:
o    Once the baseline forecast is complete, the challenge is to determine how far it could be off target.  It is important to always ask, “What things could cause this forecast to change dramatically?”  This allows marketers to identify potential risks and discontinuities such as developments in competing technologies, in customer industry competitiveness, in supplier cost structures, etc.
o    Think through and quantify the areas of greatest strategic risk.
o    Gauge the likelihood of such a development.
·         Determining an Appropriate Effort:
o    A big challenge in demand forecasting is to gauge the appropriate effort for the project’s purpose.  Ask, “How much do I need to know to make the decision at hand?”
o    Expensive forecasting is appropriate where the demand projection can significantly influence corporate strategy of where there is great uncertainty.
o    Issues which are not complicated, time is limited, or the total demand forecast is not that important don’t merit expensive analysis.