Demand forecasting

What is demand forecasting?

Demand forecasting is the act of making forecasts and estimations about future customer demand over a specific period of time, on the basis of historical data and other available information. It provides businesses with critical data regarding their potential in their current markets, as well as in other markets that they might want to expand into. This helps top management make informed decisions with regards to pricing, business growth strategies, and market potential.

Without proper demand forecasting, businesses run the risk of making poor, uninformed decisions about their products, pricing, and target markets. These decisions could have detrimental effects on profitability, customer satisfaction, and supply chain management. They could even cause your inventory holding costs to go far too high. 

Demand forecasting aids with business planning, budgeting, and goal setting. It even helps with inventory management because when you have a better, more accurate understanding of what your demand and sales could look like, you could make better-informed procurement decisions so that you can make sure that you have enough inventory to cater to the demand, without understocking or overstocking. Forecasts that have a higher degree of accuracy help you ensure that you have the right amount of stock on your hands. Now you have enough inventory to avoid stockouts, but not so much that you’ll be left with dead stock.

What is the main purpose of demand forecasting?

The main purpose of demand forecasting is to provide the business with an estimate of the quantity of products or services that its customers will demand in a specific time period. 

Demand and sales forecasting also aid businesses in optimizing their inventory, increasing inventory turnover rates, and reducing holding costs. 

It also offers businesses an insight into upcoming cash flow, which makes it possible for businesses to more accurately budget to pay suppliers and other operational costs, and invest in the growth of the business.

You can also use demand forecasting, to identify and fix any kinks in the sales pipeline in advance to make sure that your business performance remains strong throughout the entire period. Most eCommerce business owners and operators know that having too little or too much inventory can be detrimental to operations, which is why sales forecasting is important for inventory management.

Anticipating demand also helps you understand when to increase staff and other resources to keep operations running smoothly during peak periods.

What are different types of demand forecasting?

The six types of demand forecasting are:

Passive demand forecasting

Passive demand forecasting involves making use of historical sales data to predict future demand. This is the simplest type of demand forecasting. If your business has seasonal fluctuations, you should make use of historical data from the same season to project future sales for that season.

This method works well if you have a good amount of solid historical data to build on. It is a useful model for businesses that focus on stability instead of growth. This approach assumes that the current year’s sales will be similar to the previous years’ sales. It does not need you to use statistical methods or study economic trends. 

Active demand forecasting

This is goods for businesses that are in a growth phase or are just starting out. It takes your market research, marketing campaigns, and expansion plans into consideration. It also factors in external considerations like the economic outlook, growth projections for your market sector, and projected cost savings from supply chain efficiencies. This is particularly useful for startups that do not have enough historical data of their own. 

Short-term projections

This usually involves making forecasts for the next 2-3 months. It is particularly useful for managing a just-in-time supply chain. It helps you adjust your projections based on real-time sales data and respond quickly to changes in customer demand. Looking at short-term demand is especially important if your product lineup changes frequently.

Long-term projections

This involves making forecasts for the next 1 to 4 years. It aims to shape your business growth trajectory. It will be based partly on sales data and market research, but it will also be aspirational to some extent. 

You can use long-term demand forecasting to plan out your marketing, capital investments, and supply chain operations.

External macro forecasting

External macro forecasting factors in trends from the broader economy. It considers the way in which those trends will affect your goals. It can also guide and direct you on how you could meet those goals.

These forecasts might even consider the availability of raw materials and other factors that will have a direct impact on your supply chain.

Internal business forecasting

Internal business demand forecasts review your operations and check whether your business has the capacity to meet your projected demand. It could help you uncover and tackle limitations that would otherwise slow your growth.

It considers your business financing, cash on hand, profit margins, supply chain operations, and personnel. It could show you which areas you need to build capacity in to meet your goals.

What are the demand forecasting methods?

There are several demand forecasting methods available. Here are 5 of the most popular ones:

Trend projection

This uses your past sales data to project your future sales. It’s the simplest demand forecasting method, but you need to adjust future projections to account for historical anomalies. Make sure to track unusual factors in your historical data when you use the trend projection method. 

Market research

This is based on data gathered through customer surveys. It takes time and effort to send out surveys and tabulate data, but you can find valuable insights you can’t get from internal sales data. It helps you understand your customers on a deeper level.

Sales force composite

This demand forecasting technique makes use of feedback from your sales team to forecast customer demand. Since they have the most contact with customers, hear their feedback, and take requests, their insights can be very useful in understanding customer desires, product trends, and what your competitors are doing.

Delphi method

This method uses expert opinions. It lets you benefit from the knowledge of people with different areas of expertise. 

You first send a questionnaire to a group of demand forecasting experts. Then you summarize their responses and share the summary with your panel. The process keeps going for successive rounds. The answers are shared anonymously and the answers from every round influence the next set of responses. The exercise is complete when the group comes to a consensus.

Econometric method

This demand forecasting method combines sales data with information on outside forces that affect demand. You then proceed to craft a mathematical formula to predict future customer demand. This method also accounts for the relationships that exist between economic factors.