Demand Forecasting

Demand Forecasting

MCA

Demand Forecasting (169)

Demand forecasting means expectation about the future course of the market demand for a product.

Demand forecasting is a reasonable judgement of future probabilities of the market events based on scientific background.

Demand forecasting is an estimate of the future demand. It is based on the mathematical laws of probability.

Levels of Demand Forecasting

• Micro Level• Industry Level• Macro Level

Significance of Demand Forecasting in Business

• Production Planning• Sales Forecasting• Control of Business.• Inventory Control• Growth and Long Term Investment

Programme.• Stability in production and employment• Economic Planning and policy –Making

Short Term Forecasting (171)

Short term is generally not more than a year.Short term forecasts relates to the day-to-day particulars which are concerned with tactical decisions under the given resource constraints.• Evolving a sales promotion• Determining Price Policy• Evolving a purchase policy• Fixation of Sales Targets• Determining short term financial planning

Long- Term Forecasting

Long term forecasting refers to the forecasts prepared for long period (3 to 5 years/ decade) during which the firm’s scale of operations or the production capacity may be expanded or reduced.• Business Planning• Manpower Planning• Long Term Financial Planning

General Approach to Demand Forecasting

• Specification of Objectives• Identification of Demand Determinants(three types of Demands- Demand for

consumer’s durable goods, Consumer’s non durable goods, capital goods)

The sources of Data Collection for Business Forecasting

• Primary and Secondary Data• Primary sources of data1. Market Survey/ Studies or Survey Method2. Market Experimentation• Secondary sources of Data1. Official publications of the Central, State and Local Governments-Annual Survey

of Industries, Economic Survey2. Trade and Technical or Economic journals and publications-3. Official Publication like monthly Report of RBI, Annual Report on Currency and

Finance4. Official Publications of International Bodies like UNO, IMF, World Bank.5. Market Reports Trade Bulletins published by Stock Exchange, Chambers of

Commerce etc6. Publication Report brought out by research Institutions, etc.7. Unpublished Data such as Firm’s Account.

Primary Methods

• Market Survey/ studies or the Survey Method.• Market Experimentation.

Market Survey and StudiesThe market surveys are conducted to obtain the following types of Information.

1. Total Market Demand2. Increase in Demand3. Firm’s share in the market Demand4. Consumers’ income levels.5. Elasticities of Demand in relation to the price and income change.6. Consumers’ motives.7. Consumers’ preferences, habits, tastes, etc.8. Consumers’ intentions and expectations.9. Consumers’ reactions towards product improvement.10. Consumers’ attitudes towards substitutes and complementary products.11. Impact of sales promotion effort on demand.12. Social Status of buyers.13. Buyers’ age, sex and educational level.14. Impact of government policies on the market behaviour.

The Market Survey

• The Market Survey is the most direct approach to demand forecasting.

• A census market inquiry means the inquiry of the entire universe or population, It may be adopted in capital goods market where number of buyer- firms is limited.

• In large cases market survey is essentially a sample survey.

Survey Method

• The Consumer Survey.• The survey of sales forces or the collective

opinion.

The Consumer Survey

• It is undertaken by questioning consumers about what they are planning or intending to buy. A questionnaire may be prepared and mailed to the consumers. Or it may be sent through enumerators.

• In the questionnaire, the respondents may be asked for their reactions to hypothetical changes in demand determinants such as price , income, prices of substitutes, advertising etc.

The Consumer Survey (cont)

• The information collected through questionnaires are thoroughly scrutinized and edited to check inconsistencies, inaccuracy and incorrectness of the data supplied.. It will be classified and tabulated for systematic presentation and analysis.

• Personal Observations or the personal Interview method may be adopted to collect information when there is a small sample size of consumer survey.

Consumer Survey Method

merits• Imp to know consumer

expectations regarding future prices, income, inflation, product improvement.

• To Know the Demand for the new product, as no past data is available.

• It is useful for knowing the demand for industrial products, engineering goods , consumer durables, housing etc., where buyers usually plan their purchases much in advance.

demerits• Expensive• Time Consuming• The answers may not be

correct or consumers may not co-operate.

• Information may be limited or incomplete.

• Failure of Designing a questionnaire

• Cheating on the part of the enumerators

The Collective Opinion

• It is also referred to sales force polling and experts’ opinion survey.

• Under this method the salesmen have to report to the head office their estimates of expectations of sales in their territories.

• Eg information obtained from retailers and wholesalers, Opinion from the expert etc.

The Collective Opinion Method

• Merits• It is Cheaper and easy to

handle.• Less time consuming• It is based on the value

judgement of the salesmen. It can be used for forecasting the sales for new products. It is also regarded as “hunch” method of business forecasting.

• Demerits• It is subjective• It is subject to a high

element of bias of the reporting agency.

• Its accuracy depends on the intelligence of the reporting salesman.

Cost-Output Relationship

• In producing a commodity (or a service) a firm has to employ an aggregate of various factors of production such as land, labour, capital and entrepreneurship.

• These factors are to be compensated for their efforts and contribution made in producing the commodity . This is the cost.

• Cost of the production is the value of the factors of production employed.

Types of Cost (204)

(1) Real Cost- The real cost of production refers to the exertion of labour, sacrifice involved in the moderation from present consumption by the savers to supply capital, and social effects of pollution, congestion, and environmental distortions.

Real cost refers to the physical quantities of various factors.

Types of Cost cont.(2) Opportunity Cost/ Alternative Cost- The alternative or opportunity cost of one unit of product A is the amount of product B that has been sacrificed by allocating the resources to produce rather than B.(3) Money Cost- Monetary expenditure on inputs of various kinds- raw materials, labour etc., required for the output.(a) Explicit Cost- Explicit Costs are direct contractual

monetary payments incurred through market transactions.

(b) Implicit Cost- Implicit Costs are the opportunity costs of the use of factors which a firm does not buy or hire but already own.

Types of Cost cont.(4) Accounting Cost- In the Cost of production only the cash payments to the factors of production , made by an entrepreneur, for the services rendered by these factors in productive process. Ie explicit cost.(means only wages, interest, rent payments but not the profits.)

(5) Economic Cost- In this cost implicit cost is included.

Types of cost cont.(6) Fixed Cost (supplementary Cost)- Fixed Costs are those costs that are incurred as a result of the use of fixed factor inputs. They remain fixed at any level of output in the short-run.Payments of rent for building, interest paid on capital, insurance premiums, Depreciation and maintenance allowances, administrative expenses – salaries of managerial and office staff, property and business taxes, license fees etc.

Types of Costs cont.(7) Variable Costs-(Prime costs)- Variable costs are those costs that are incurred by the firm as a result of the use of variable factor inputs. They are dependent upon the level of output.Short run variable cost includesPrices of raw materials, Wages of labour, Fuel and power charges, Excise duties, sales tax, transport expenditure etc.

Types of production costs and their measurement

(1) Total Cost (TC)- Total Cost is the aggregate of expenditure incurred by the firm in producing a given level of output.

TC= TFC + TVC(2) Total Fixed Cost (TFC) – TFC corresponds to fixed inputs in the short run production function. It is obtained by summing up the product of quantities of the fixed facots multiplied by their respective unit prices. TFC remains same at all levels of output in the short run.

Types of production cost cont.(3) Total Variable Cost (TVC) – Corresponding to variable inputs in the short run production, is the total variable cost. It is obtained by summing up the product of quantities of input multiplied by their prices.(4) Average Fixed Cost (AFC) – Average fixed cost is total fixed cost divided by total units of output.

Types of production cost cont.-

(5) Average Variable Cost (AVC)- Average variable cost is total variable cost divided by total units of output. (6) Average Total Cost (ATC) – Average total cost or average cost is total cost divided by total units of output.

Types of Production Cost cont- (7) Marginal Cost (MC)- Marginal Cost is the cost of producing an extra unit of output.MC4 = TC4- TC3

Cost Function (Cost-Output Relationship )

• Cost function expresses the relationship between cost and output.

• C = f(Q, S, T, P……)• C = Cost of Production• F = Functional Relationship• Q = Quantity of output• S = Size of the plant• T = Time• P = prices of the factor of inputs.

Short-run Cost Function Short run is that period of time during which capacity can be adjusted to changing market conditions.In the short run, some inputs are fixed in amount ; a firm can expand or contract its output only by varying the amounts of other inputs. Usually, a capital equipment, plant and machinery, entrepreneurship, skilled labour etc are fixed in the short run.

Short run costs are the costs incurred by a firm over a period during which some factors of production are fixed, whereas long run costs are the costs incurred by a firm over a period during which all factors of production are available.In the short run, the costs of the firm are divided into fixed costs and variable costs for making correct decisions.TC= TFC+ TVCTFC (salaries of administrative staff, depreciation of machinery, expenses for building, depreciation and repairs, expenses for land maintenance etc)Total Variable costs (TVC) (expenses on raw materials, cost of direct labour, running expenses of fixed capital such as fuel, power, ordinary repairs, and routine maintenance.Total Cost (TC)- TC of a firm in the short run is the sum total of the total fixed cost and the total variable cost.

• AFC = FC/ Q• AVC = VC/ Q• Average Fixed Cost curve represents the fixed cost per

unit of output produced. This curve is a rectangular hyperbola which means that it approaches the vertical and horizontal at each end. It implies that for every small outputs, fixed cost per unit is high and for large outputs, it is low.

• AVC represents variable cost per unit of output produced. This curve declines at first, reaches a minimum and then rises.

ATC curve represents total cost per unit of output produced. This curve is the sum of AFC curve and AVC curve at each output. As per figure 9.6, AVC which is representing variable cost per unit of output produced declines at first, reaches a minimum then rises.ATC Curve represents total cost per unit of output produced. ATC = AFC+AVC .MC cuts the ATC and AVC curve at their lowest points. When MC is below it pulls ATC curve below and when it rises upward it pulls thee later upward.

Long-Run Cost Function

Long run is that period of time during which capacity adjustment can be made to meet changing market conditions . In the long run, all inputs are variable in amount; a firm can expand its output by building and operating a wholly new and large plant. Its output can range from zero to an indefinitely large quantity.Long run costs are the costs incurred by a firm over period during which all factors of production are variable.

• The long run average cost curve is derived from short run cost curves.

• LAC = LTC/Q• Long run average cost curve has a U shape. This shape

reflects the laws of returns to scale. According to these laws, the unit cost of production decreases as plant size increases, due to economies of scale. The economies of scale exist only up to a certain size of plant, ie optimum plant size, beyond which diseconomies of scale will arise due to managerial inefficiencies. This makes the LAC curve turn upwards. In this stage decision making process becomes less efficient.

1. At each level of output, the relevant short-run marginal cost (SMC) equals Long run marginal cost (LMC)

2. For all SAC Curves, the point of tangency with LAC Curve is at an output less than or greater than the output of minimum SAC.

3. The average cost per unit falls upto output OXM, due to economies of large scale production: and any increase in scale beyond plant size SAC2 results in increasing average cost per unit because of the existence of diseconomies of large scale production.

Cost Control

• Cost Control means the regulation of the costs of operating a business firm. It is an efficient tool of management of the firm. It is a by –product of effective management in business. Its emphasis is on the past and the present.

• Cost Control is essential in the main areas such as direct material, direct labour, sales and overheads.

• The steps involved are planning, Communication, Motivation, Appraisal and reporting, Decision Making.

Techniques of Cost Control1] Budgetary Control- It is a system in which there is constant checking and evaluation of actual results compared with the budget goals. 2] Standard Costing – is defined as the preparation and use of standard costs, their comparison with actual costs. Standard Costs are pre-determined costs. The degree of success is measured by a comparison of actual performance and standard performance. 3] Inventory Control- It aims at minimizing blockages of financial resources. It is also adopted to reduce investment in inventory and to avoid their losses.

4] Ratio Analysis- It is a tool of comparison. It acts as an effective cost control technique. In this analysis a desirable ratio is pre determined. The actual performance is compared with this ratio and corrective action is taken.5] Value Analysis –It is a technique of cost control which studies cost in relation to product design. It is a process which aims at having a product design, material usage etc.

6] Work study- The work study technique of cost control involves systematic collection of work data and critical evaluation of the existing and proposed methods of undertaking the work. It aims at analyzing and evaluating all those conditions which influence the performance of the task.

Cost Reduction• Cost Reduction means the real and permanent

reduction in the unit costs of products produced and services rendered without impairing their suitability for the intended use. Its emphasis is on the present and the future.

• Main Areas such as product design, organization, production, purchase and material cost, labour cost and so on.

• Areas listed as well defined and reasonable programmes, proper organization, efficient system of data collection and reporting, Close scrutiny of the past and the present operations.

Techniques of Cost Reduction

• The various techniques of cost reduction are Budgetary Control, Standard costing, Value analysis, Work analysis.

• The success of any cost reduction programme depends on the nature of organization undertaking the programme. It requires co-operation at all levels of management analysis and implementation.

Economies of scale (239)

Economies of scale simply means the advantages of large scale production of a firm. There are two types of Economies.Internal Economies :Internal economies are those which arise from a particular firm as it expands the size of the firm.

Types of Internal Economies

1. Technical economies- These are the advantages enjoyed by a firm due to its technical efficiency, which is resulted from the use of machine which can save labour and produce on a large scale. Insurance companies and banks make use of machines for calculation and enjoy this advantage.

2. Managerial economies-these advantages are enjoyed by the management of the firm by creating special departments or specialization. Eg accounts dept, research dept division of labour etc. This helps to increase the efficiency.

I have simplified it.

3. Financial economies – the advantage firm gets in raising adequate finance or capital. Large business firms are considered as trust worthier and stable. Banks offer loans at cheaper rate and share market earns by selling shares of large firm.4. Commercial economies- These advantages are enjoyed in buying raw materials and other means of production and selling the finished products . Firms enjoy concessions from railway, road transport, cheap credit from banks, prompt delivery, careful attention, concessions from dealers.

Key to remember- MaTeFiCoRi

5. Risk- bearing economies- Large firms comparing to smaller firms bear risks or losses better. A loss in one section is compensated by profit in another section.

External Economies

• External economies are the advantages enjoyed by all the firms in an industry which is localized at a particular place. These advantages are common to all the firms in the industry. The external economies include …..

Types of external economies 244Key = IBCD

• Economies of concentration (localization) - This refers to the advantages arise from the availability of skilled labourers, better transport and credit facilities.

• Economies of Information (technical and marketing Intelligence) - This refers to the advantages derived from the publication of trade and technical journals and from central research institutions.

• Economies of disintegration-When an industry grows, it is possible to split up some of the whole processes which are taken over by specialized firms.

• Economies of by-products –A large Industry can make use of waste materials for manufacturing by products.

Diseconomies of scale

• Diseconomies of scale simply means the disadvantages of large scale production facing by a business firm.

• TYPES OF DISECONOMIES OF SCALE:• Difficulties of Management- As a firm expands,

complexities and problems of management increase. The manager find it difficult to control and supervise the organization. This proves to uneconomical.

• Difficulties of co-ordination- Organization, co-ordination, decision making becomes difficult.

• Difficulties in Decision Making- A large firm cannot take quick decisions and make quick changes as and when they are needed, for it has to consult various departments for making any decisions and so urgent matters requiring timely decisions are inevitably delayed.

• Increased Risks- With the scale investment also increases and risks too. Therefore unwillingness to bear greater risks is an important limitation to the expansion of the size of the firm.

• Labour diseconomies-Extreme Division of labour with a growing scale of output results in lack of initiative and drive in the executive personnel. Occurrence of grievances and Industrial dispute is common.

• Scarcity of Factor Supplies – Due to concentration firms faced scarcity of factors of production.

• Financial Difficulties – A big concern needs huge capital which cannot always be easily obtainable.

• Marketing Diseconomies –Firms under the monopolistic competition undertake extensive advertising and sales promotion efforts and expenditure which ultimately lead to higher costs.