Four Steps to Forecast Total Market Demand Essay

Such foreshadows argon crucial since companies must mystify building pertly generating plants five to ten years before they ar to come on line. But during the 19751985 period, load actually grew at exactly a 2% regularize. Despite the postponement or basiscellation of mevery projects, the wasted generating capacity has hurt the constancy financial situation and led to higher(prenominal) client rates. ? The petroleum manufacture invested $500 billion worldwide in 1980 and 1981 beca employment it expected anele prices to rise 50% by 1985. The estimate was establish on bets that the food foodstuff would grow from 52 million barrels of oil a day in 1979 to 60 million barrels in 1985. optionly, require had fallen to 46 million barrels by 1985. Prices collapsed, creating grand losses in drilling, fruition, refining, and directping investments. Bill Barnett is a principal in the Atlanta office of McKinsey & Company. He is a top outer of the firms Micro economics Center, and his client work has focused on dividing line unit and merged strategy. ? In 1983 and 1984, 67 new types of business personal computers were introduced to the U. S. mart, and most companies were expecting fickle step-up. One industry imagineing service projected an installed base of 27 million units by 1988 an opposite predicted 28 million units by 1987.In fact, only 15 million units had been shipped by 1986. By past, many manufacturers had given over the PC grocery store or gone out of business altogether. The wide of the mark suppositions did non stem from a lack of forecasting techniques regression analysis, historical slew smoothing, and early(a)s were available to all the players. Instead, they sh ard a mistaken thoroughgoing assumption that relationships driving adopt in the past would continue unaltered. The companies didnt foresee changes in end-user conduct or empathise their markets saturation point.None realized that history can be an perfidious guide as domestic economies become more international, new technologies emerge, and industries evolve. As a result of changes resembling these, many managers go come to suspect traditional techniques. some(a) even throw up their hands and resume that business planning must proceed without right-hand(a) implore forecasts. I disagree. It is possible to coach valuable insights into in store(predicate) market conditions and enquire trains found on a chummy understanding of the forces behind total-market take on. These insights can likenessright 1988 by the President and Fellows of Harvard College. All rights reserved. any(prenominal) beats piddle away the difference surrounded by a winning strategy and one that flounders. A forecast of total-market shoot wont guarantee a successful strategy. But without it, decisions on investment, marketing support, and former(a) resource allocations will be based on hidden, unconscious assumptions round industrywide requirements, and they ll often be wrong. By gauging total-market demand explicitly, you scram a better chance of controlling your beau mondes destiny. barely going through the process has merit for a management team up. Instead of just coming out with pat answers, numbers, and targets, the team is forced to conceive the competitive environment. Total-market forecasting is only the first microscope stage in creating a strategy. When youve finished your forecast, youre not done with the planning process by any means. There are four measuring rods in any total-market forecast 1. Define the market. 2. Divide total industry demand into its master(prenominal) components. 3. Forecast the drivers of demand in apiece segment and project how they are likely to change. . Conduct sensitivity analyses to understand the most critical assumptions and to aegir risks to the baseline forecast. Defining the Market At the outset, its best to be overly inclusive in defining the total market. Define it loosely enoug h to include all potential end users so that you can both identify the earmark drivers of demand and reduce the risk of surprisal 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 mass in offices and their needs and habits, bandage total demand for PBX systems depends on how they equivalence on price and benefits with substitute products like the local telephone play alongs central office electrical switch service. Beyond this, demand for a particular PBX is a go bad of price and benefit comparisons with other PBXs. In defining the market, an understanding of product substitution is critical. Customers might be generate diversely if the price or performance of potential substitute products changes.One beau monde studying total deman d for industrial paper tubes had to consider nearly related uses of metal and charge plate tubes 4 to prevent customer switching among tubes from biasing the results. Understand, too, that a completely new product could displace one that even so had comprised the entire marketlike the electronic calculator, which eliminated the slide rule. For a go after AT&Ts divestiture, the Bell telephone companies keep to forecast volume 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 some(prenominal) ways you can make sure you include all of the essence(p) substitute products (both current and potential). From interviews with industrial customers you can learn about substitutes t hey are studying or about product drill patterns that imply future switching opportunities.Moreover, market research can lead to insights about consumer products. disquisition with experts in the relevant technologies or reviewing technological literature can sponsor 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 fecess 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 mortal 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 tainting coffee if all coffee prices rise. In some theatrical roles, managers can make quick persuasions about market definition.In other cases, theyll have to give their market considerable 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 companion 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 dog-tired time on that subject. Dividing pauperization into Component Parts The second step in forecasting is t o divide total demand into its main components for smash analysis.There are both criteria to keep in mind when choosing segments make all(prenominal) 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 expenditure 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). because 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 entropy 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 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 real(a) secondary branches of the tree to further dissect these categories and to determine their drivers of demand. It analyzed the be segments less completely (that is, via a regression against broad macroeconomic trends). separate companies have used similar methods to segment total demand. One company separate demand for maritime 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 actual homes, and appliance penetration 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. certain 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 hi storical data or to abbreviate their own market research programs, which can be time go through 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 individual(a) 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 attention 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 comfortably be based to other factors where data are much harder to find. past 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 inwardnessively. 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 ye ar Business Forms Commercial Printing Reprographics Envelopes Other Converting Total Demand letter paper 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 ingenuous 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 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 channelise in the demand curvetoward a greater quantity demanded at a given price. ) Demand growth for reproduction 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 hails 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 make an indicative demand curve for copy paper. See the chart understand 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 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 elfin 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 fu nction 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 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 s hips.