What are the uncertainties in demand forecasting?

Answer 1

Uncertainties in Demand Forecasting

Demand forecasts are subject to error and uncertainty which arise from three different sources:

Ø Data about past and present market

Ø Methods of forecasting

Ø Environment change

Data about past and present market:

The analysis of past and present markets, which serve as the springboard for the projection exercise, may be vitiated by the following inadequacies of data:

Lack of Standardization: Data pertaining to market features like product, price, quantity, cost, income, etc. may not reflect uniform concepts and measures.

Few observations: observations available to conduct meaningful analysis may not be enough.

Influence of abnormal factors: Some of the observations may be influenced by abnormal factors like war or natural calamity.

Method of forecasting:

Methods used for demand forecasting are characterized by the following limitations:

Inability to handle unquantifiable factors: most of the forecasting methods, being quantitative in nature, cannot handle unquantifiable factors which sometimes can be of immense significance.

Unrealistic assumptions: Each forecasting method is based on certain assumptions. For example, the trend projection method is based on the mutually compensating affects premise and the end use method is based on the constancy of technical coefficients. Uncertainty arises when the assumptions underline the chosen method tend to be realistic and erroneous.

Exercise data requirement: In general, the more advanced a method, the greater the data requirement. For example, to use an econometric model one has to forecast the future values of explanatory variables in order to project the explained variable.

Environmental Changes:

The environment in which a business functions is characterized by numerous uncertainties. The important sources of uncertainty are mentioned below:

Technological Change: This is a very important and very hard-to-predict factor which influences business prospects. A technological advancement may create a new product which performs the same function more efficiently and economically, thereby cutting into the market for the existing product. For example, electronic watches are encroaching on the market for mechanical watches.

Shift in Government Policy: Government resolution of business may be extensive. Changes in government policy, which may be difficult to anticipate, could have a telling effect on the business environment.

Development on the International Scene: Development on the International Scene may have a profound effect on industries.

Discovery of New Sources of Raw Material: Discovery of new sources of raw materials, particularly hydrocarbons, can have a significant effect on the market situation of several products.

Vagaries of Monsoon: Monsoon, if plays an important role in the economy of a country, is somewhat unpredictable. The behavior of monsoon influences, directly or indirectly, the demand for a wide range of products.

Coping with Uncertainties:

Given the uncertainties in demand forecasting, adequate efforts, along the following lines, may be made to cope with uncertainties.

Ø Conduct analysis with data based on uniform and standard definitions.

Ø In identifying trends, coefficients, and relationships, ignore the abnormal and out-of-the-ordinary observations.

Ø Critically evaluate the assumptions of the forecasting methods and choose a method which is appropriate to situation.

Ø Adjust the projections derived from quantitative analysis in the light of unquantifiable, but significant, influences.

Ø Monitor the environment imaginatively to identify important changes.

Ø Consider likely alternative scenarios and their impact on market and competition.

Ø Conduct sensitivity analysis to access the impact on the size of demand for unfavorable and favorable variations of the determining factors from their most likely levels.

Answer 2

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