Four Steps to Forecast Total Market Demand Essay

Such forecasts are crucial since companies must begin building new generating plants five to ten years before they are to come on line. But during the 19751985 period, load actu wholey grew at only a 2% rate. Despite the postponement or send awaycellation of many projects, the excess generating capacity has hurt the regorgeience financial situation and led to higher customer rates. ? The petroleum labor invested $500 billion worldwide in 1980 and 1981 because it expected oil prices to rise 50% by 1985. The estimate was found on forecasts that the trade would grow from 52 one thousand thousand barrels of oil a day in 1979 to 60 one million million barrels in 1985.Instead, choose had fallen to 46 million barrels by 1985. Prices collapsed, creating huge losses in drilling, production, refining, and shipping investments. Bill Barnett is a promontory in the Atlanta office of McKinsey & Company. He is a consumeer of the firms Microeconomics Center, and his client work has foc ut ilize on business unit and bodied strategy. ? In 1983 and 1984, 67 new types of business personal computers were introduced to the U. S. market, and most companies were expecting explosive growth. angiotensin converting enzyme assiduity forecasting service projected an installed base of 27 million units by 1988 an different predicted 28 million units by 1987.In fact, only 15 million units had been shipped by 1986. By past, 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 compend, historical trend smoothing, and separatewises were available to all the players. Instead, they shared a mistaken fundamental assumption that relationships driving requirement in the past would gallop unaltered. The companies didnt foresee changes in end-user behavior or understand their markets saturation point.None realized that history can be an unreliable guide as domestic economies become to a greater extent international, new technologies emerge, and industries evolve. As a result of changes uniform these, many managers have come to distrust traditional techniques. Some even throw up their hands and assume that business intend must proceed without good select forecasts. I disagree. It is possible to develop valuable insights into future market conditions and ingest levels based on a deep understanding of the forces behind total-market demand. These insights canCopyright 1988 by the President and Fellows of Harvard College. All rights reserved. somewhattimes 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 aliment, and other resource allocations will be based on hidden, unconscious assumptions about attentionwide requirements, and theyll often be wrong. By gauging total-market demand explicitly, you have a better find out of controlling your companys destiny.Merely going through the process has merit for a management team. Instead of just coming out with pat answers, numbers, and targets, the team 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. thither are four steps in any total-market forecast 1. Define the market. 2. Divide total industry demand into its main components. 3. Forecast the causers of demand in each segment and project how they are likely to change. . Conduct sensitivity analyses to understand the most unfavourable assumptions and to count on risks to the baseline forecast. Defining the Market At the outset, its best to be overly inclusive in defining the total market. Define it broadly abundant to include all potential end users so that you can both identify the appropriate drivers of demand an d reduce the risk of surprise product substitutions. The factors that drive forecasts of total-market size differ markedly from those that determine a particular products market share or product-category share.For example, total-market demand for office telecommunications products nationally depends in part on the number of people in offices and their needs and habits, while total demand for PBX systems depends on how they compare on price and hits with substitute products like the local telephone companys central office switch over 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 detailed. Customers might behave differently if the price or performance of potential substitute products changes.One company studying total demand for industrial stem tubes had to consider closely related uses of metal and charge card tubes 4 to prevent customer switchin g among tubes from biasing the results. Understand, too, that a completely new product could displace one that hitherto had comprised the entire marketlike the electronic calculator, which eliminated the slide rule. For a while afterwards AT&Ts divestiture, the Bell telephone companies continued to forecast volume of long-distance calls by using historical trend lines of their revenuesas if they were dormant 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 ambition from other longdistance carriers. There are several ways you can make sure you include all primal substitute products (both current and potential). From interviews with industrial customers you can learn about substitutes they are studying or about product usage patterns that imply future switching opportunities.Moreover, market look into can lead to insight s 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 rate 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 paper.Analyses like these can lead to the construction 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 coffee if Maxwell Houses prices increase than they are to stop buying coffee if all coffee prices rise. In some cases, man agers can make lively judgments about market definition.In other cases, theyll have to give their market considerable thought and analysis. A total-market forecast whitethorn 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 whitethorn be to understand product substitution and competitiveness. One company analyzed the potential market for new consumer feed 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 washed-out 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.There are two criteria to keep in mind when choosing segments make each category small and homogeneous enough so that the drivers of demand will obligate 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 ascertain 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 data permitted the division of demand into 12 end-use categories.Some categories, like business forms and reprographic paper, were big contributors to total consumption others, such as lab els, 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 unoriginal 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 demand for maritime planet terminals by type of ship (e. g. , seismic ships, bulk/ dispatch/container ships). Another divided demand for long-distance telephone service into business and residential customers and then subdivided it by usage level. And a one-third segmented consumer appliances into lead purchase typesappliances used in new home construction, replacement appliance sales in existing homes, and appliance penetration in existing homes.In thinking about market divisions, managers nee d to decide whether to use existing data on segment sizes or to commission research to get an main(a) estimate. Reliable public information on historHARVARD BUSINESS REVIEW JulyAugust 1988 ical demand levels by segment is available 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 timeconsuming and expensive. Note that while such segmentation is sufficient for fore casting 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 limited 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 find 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 Category Business Forms Commercial Printing Reprographics Envelopes Other Converting Total Demand letter paper and Tablet Books Directories Catalogs Magazines Inserts Labels Reviewed in DepthPercen t 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 pink-collar workers, population, and economic performance. Most of the factors had a significant effect on demand. Intuitively, it also made 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 copy 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 represents had caused this increased usage. The relationship was proved by estimating the substantial cost reductions that had occurred, combining t hose with numbers of tons produced over time, and then fashioning an indicative demand curve for copy paper. See the chart Understanding 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 describe this as a levelward-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 forecasts to develop a base case economic forecast. Similar studies have been perfo rmed 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% higher up 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.