Four Steps to Forecast Total Market Demand Essay Example for Free

Four Steps to Forecast Total Market Demand EssaySuch forecasts are crucial since companies must get off building raw generating plants five to ten years before they are to come on line. But during the 19751985 period, load actually grew at just a 2% rate. Despite the postp geniusment or sightcellation of more projects, the excess generating capacity has hurt the industry financial situation and led to higher guest rates. ? The oil color industry invested $500 billion worldwide in 1980 and 1981 because it expected oil prices to rise 50% by 1985. The estimate was based on forecasts that the market would prepare from 52 wizard thousand thousand barrels of oil a day in 1979 to 60 million barrels in 1985. Instead, fill had fallen to 46 million barrels by 1985. Prices collapsed, creating huge losses in drilling, production, refining, and shipping investments. Bill Barnett is a principal in the Atlanta delegacy of McKinsey Company. He is a attraction of the firms Microeco nomics Center, and his client work has foc employ on business unit and corporate strategy. ? In 1983 and 1984, 67 new-sprung(prenominal) types of business personal computers were introduced to the U. S. market, and almost companies were expecting explosive growth. One industry calculate service projected an installed base of 27 million units by 1988 a nonher predicted 28 million units by 1987.In fact, only 15 million units had been shipped by 1986. By then, many manufacturers had abandoned the PC market or gone out of business altogether. The inaccurate suppositions did not stem from a lack of forecasting techniques regression analysis, historical trend smoothing, and another(prenominal)s were purchasable to all the players. Instead, they shared a mistaken fundamental assumption that relationships impulsive gather up in the past would continue unaltered. The companies didnt foresee changes in end-user look or chthonicstand their markets saturation localize.None recognise that history place be an unreliable guide as domestic economies become more international, new technologies emerge, and industries evolve. As a result of changes homogeneous these, many managers have come to distrust traditional techniques. around even throw up their hands and assume that business planning must proceed without in force(p) demand forecasts. I disagree. It is possible to explicate valuable insights into future market conditions and demand levels based on a deep understanding of the forces behind union-market demand. These insights notifyCopyright 1988 by the President and Fellows of Harvard College. All rights reserved. sometimes make the difference between a winning strategy and one that flounders. A forecast of total-market demand wont guarantee a successful strategy. But without it, decisions on investment, marketing support, and other resource allocations will be based on hidden, unconscious(p) assumptions about industrywide requirements, and theyll often be wrong. By gauging total-market demand explicitly, you have a better chance of controlling your companys destiny.Merely going by means of the process has merit for a management police squad. Instead of just coming out with pat answers, numbers, and targets, the group is forced to rethink the competitive environment. Total-market forecasting is only the first stage in creating a strategy. When youve finished your forecast, youre not done with the planning process by any means. There are iv steps in any total-market forecast 1. Define the market. 2. Divide total industry demand into its main components. 3. Forecast the drivers of demand in each atom and project how they are likely to change. . Conduct sensitivity analyses to understand the most critical assumptions and to gauge risks to the baseline forecast. Defining the Market At the outset, its silk hat to be overly inclusive in defining the total market. Define it broadly enough to include all authorization end users so t hat you rouse both identify the appropriate drivers of demand and reduce the risk of surprise product surrogates. The factors that drive forecasts of total-market size differ markedly from those that determine a grouchy products market share or product- family unit share.For example, total-market demand for office telecommunications products nationally depends in part on the number of people in offices and their ineluctably and habits, while total demand for PBX systems depends on how they compare on price and benefits with substitute products like the local telephone companys central office switching service. Beyond this, demand for a particular PBX is a function of price and benefit comparisons with other PBXs. In defining the market, an understanding of product substitution is critical. Customers might behave differently if the price or performance of potential substitute products changes.One company studying total demand for industrial authorship tubes had to consider close ly related uses of metal and plastic tubes 4 to prevent customer switching among tubes from biasing the results. Understand, too, that a altogether new product could displace one that hitherto had comprised the entire marketlike the electronic calculator, which eliminated the slide rule. For a while after ATTs divestiture, the Bell telephone companies continued to forecast vividness of long-distance calls by using historical trend lines of their revenuesas if they were still part of a monopoly.Naturally, these forecasts grew more inaccurate with time as end users were presented with new choices. The companies are now broadening their market definitions to take account of heightened competition from other longdistance carriers. There are several ways you locoweed make certainly you include all important substitute products (both current and potential). From interviews with industrial customers you raft learn about substitutes they are studying or about product practice session patterns that imply future switching opportunities.Moreover, market research can lead to insights about consumer products. Speaking with experts in the relevant technologies or reviewing technological literature can help you identify potential developments that could threaten your industry. Finally, careful quantification of the economic value of alternative products to different customers can yield deep insights into potential switching behaviorfor example, how oil price movements would affect plastics prices, which in turn would affect plastic products ability to substitute for metal or reputation.Analyses like these can lead to the building of industry demand curvesgraphs representing the relationship between price and volume. With an appropriate definition, the total-industry demand curves will often be steeper than demand curves for individual products in the industry. Consumers, for example, are far more likely to switch from Maxwell House to Folgers drinking chocolate if M axwell Houses prices increase than they are to stop buying coffee if all coffee prices rise. In some cases, managers can make quick judgments about market definition.In other cases, theyll have to give their market wide thought and analysis. A total-market forecast may not be critical to business strategy if market definition is very difficult or the products under study have small market shares. Instead, your principal challenge may be to understand product substitution and competitiveness. One company analyzed the potential market for new consumer food cans, and it concluded that growth trends in food product markets were not critical to the strategy question. What was critical was knowing the value positions of the new packagesJulyAugust 1988 elative to metal cans, glass jars, and composite cans. So the company spent time on that subject. Dividing Demand into Component Parts The second step in forecasting is to divide total demand into its main components for separate analysis.T here are two criteria to keep in mind when choosing segments make each category small and homogeneous enough so that the drivers of demand will apply consistently across its various elements make each large enough so that the analysis will be worth the effort. Of course, this is a matter of judgment. You may find it useful in aking this judgment to imagine alternative segmentations (based on enduse customer groups, for example, or type of purchase). Then hypothesize their key drivers of demand (discussed later) and decide how much detail is required to capture the true situation. As the assessment continues, managers can return to this stage and reexamine whether the initial decisions still stand up. Managers may wish to use a tree diagram like the accompanying one constructed by a management team in 1985 to study demand for paper. In this disguised example, industry information permitted the division of demand into 12 end-use categories.Some categories, like business forms and rep rographic paper, were big contributors to total consumption others, such as labels, were not. One (other converting) was fairly large but too diverse for deep analysis. The team focused on the four segments that accounted for 80% of 1985 demand. It then developed secondary branches of the tree to further dissect these categories and to determine their drivers of demand. It analyzed the remaining segments less completely (that is, via a regression against broad macroeconomic trends).Other companies have used similar methods to segment total demand. One company divided up demand for naval satellite terminals by type of ship (e. g. , seismic ships, bulk/cargo/container ships). Another divided demand for long-distance telephone service into business and residential customers and then subdivided it by usage level. And a third segmented consumer appliances into three purchase typesappliances used in new home construction, replacement appliance sales in existing homes, and appliance pen etration in existing homes.In thinking about market divisions, managers need to decide whether to use existing data on segment sizes or to commission research to get an independent estimate. Reliable public information on historHARVARD BUSINESS REVIEW JulyAugust 1988 ical demand levels by segment is acquirable for many big U. S. industries (like steel, automobiles, and natural gas) from industry associations, the federal government, off-the-shelf studies by industry experts, or ongoing market data services. For some foreign markets and less well-researched industries in the United States, like the labels industry, you may have to get independent estimates.Even with good data sources, however, the readily available information may not be divided into the best categories to support an insightful analysis. In these cases, managers must decide whether to develop their forecasts based on the available historical data or to undertake their own market research programs, which can be time consume and expensive. Note that while such segmentation is sufficient for forecasting total demand, it may not create categories useful for developing a marketing strategy. A single product may be driven by entirely different factors.One study of industrial components found that consumer industry categories provided a good basis for projecting total-market demand but gave only particular(a) help in formulating a strategy based on customer preferences distinguishing those who buy on price from those who buy on service, product quality, or other benefits. Such buying-factor categories generally do not correlate with the customer industry categories used for forecasting. A strong sales force, however, can identify customer preferences and develop appropriate account tactics for each one. Forecasting the Drivers of DemandThe third step is to understand and forecast the drivers of demand in each category. Here you can make good use of regressions and other statistical techniques to fi nd some causes for changes in historical demand. But this is only a start. The tougher challenge is to look beyond the data on which regressions can easily be based to other factors where data are much harder to find. Then you need to develop a point of view on how those other factors may themselves change in the future. An end-use analysis from the commodity paper example, reprographic paper, is shown in the accompanying chart.The management team, using available data, divided reprographic paper into two categories plain-paper copier paper and nonimpact page printer paper. Without this important differentiation, the drivers of demand would have been masked, making it hard to forecast effectively. In most cases, managers can safely assume that demand is affected both by macroeconomic vari5 Components of Uncoated White Paper Making Up Total Demand (thousands of tons) End-Use syndicate Business Forms Commercial Printing Reprographics Envelopes Other Converting Total Demand Stationery and Tablet Books Directories Catalogs Magazines Inserts Labels Reviewed in DepthPercent of Total 1985 Demand 25% 25 20 10 5 5 5 1 or less ables and by industry-specific developments. In looking at plain-paper copier paper, the team used simple and multiple regression analyses to test relationships with macroeconomic factors like white-collar workers, population, and economic performance. Most of the factors had a significant effect on demand. Intuitively, it also make sense to the team that the level of business activity would relate to paper consumption levels. Economists sometimes refer to growth in demand due to factors like these as an outward shift in the demand curvetoward a greater quantity demanded at a given price. ) Demand growth for assume paper, however, had exceeded the real rate of economic growth and the challenge was to find what other factors had been causing this.The team hypothesized that declining copy costs had caused this increased usage. The relationship was proved by estimating the substantial cost reductions that had occurred, combining those with numbers of tons produced over time, and then fashioning an indicative demand curve for copy paper. See the chart judgment Copy Paper Demand Drivers. ) The clear relationship between cost and volume meant that cost reductions had been an important cause of past demand growth. (Economists sometimes show this as a downward-shifting supply curve leading to movement down the demand curve. ) Further major declines in cost per copy seemed unlikely because paper costs were expected to remain flat, and the data indicated little increase in 6 price elasticity, even if cost per copy fell further.So the team concluded that usage growth (per level of economic performance) was likely to continue the flattening trend begun in 1983 growth in copy paper consumption would be largely a function of economic growth, not cost declines as in the past. The team then reviewed several econometric services forecast s to develop a base case economic forecast. Similar studies have been performed in other industries. A simple one was the industrial components analysis mentioned before, a case where the total forecast was used as background but was not critical to the companys strategy decision.Here the team divided demand into its consuming industries and then asked experts in each industry for production forecasts. Total demand for components was projected on the assumption that it would move parallel to a weight-averaged forecast of these customer industries. Actual demand three years later was 2% above the teams prediction, probably because the industry experts underestimated the impact of the economic recovery of 1984 and 1985. In another example, a team forecasting demand for maritime satellite terminals extrapolated past penetration curves for each of five categories of ships.