Demand forecasting is a process that uses historical sales data to estimate a forecast of future demand. It is an essential process for organizations that need to estimate the number of products to produce for a specific future period. Demand forecasting has a direct impact on a business’ turnover, cash flow, and profit margins
Types of demand forecasting
The categories of demand forecasting are based on the period, the market scope, and the level of detail considered.
- Passive versus active demand forecasting: Passive demand forecasting is ideal for stable organizations with conservative growth plans, whereas active demand forecasting works well for organizations wanting to scale and diversify through aggressive growth plans.
- Short-term to long-term demand forecasting: Forecasts can be done for specific periods, such as three months (short-term), twelve to twenty-four months (medium-term), or even up to four years (long-term). Shorter-term forecasting focuses on tactical decisions, whereas organizations use longer-term demand forecasting for strategic planning and capital expenditure.
- External macro-level demand forecasting: This type of demand forecasting focuses on using macro-economic factors to evaluate the strategic objectives of an organization. It covers items such as the expansion of the organization’s product portfolio or new customer segments.
- Internal business level demand forecasting: This type of demand forecasting focuses on the organization’s internal operations, including product categories and sales. It involves cash flow and net profit margin forecasts.
Demand forecasting methods
The methods can be either quantitative or qualitative. Qualitative methods consist of the Delphi method (panel of experts do the forecasts) to market research. The quantitative techniques consist of trend forecasting or econometric forecasting.
Challenges with demand forecasting
Some of the challenges with demand forecasting include:
- Demand forecasting relies on data. If the data used as an input into demand forecasting is not accurate, the forecasts will not be accurate. Organizations should ensure that their data is of the best quality possible.
- Lack of historical data: Newer organizations may not have much historical sales data, but even older organizations may not have collected data for several years.
Benefits of demand forecasting
Some of the benefits of demand forecasting include:
- Rationalization of cash flow: An organization’s past balance sheet will show how its sales revenue coordinates with the costs of products sold, which helps an organization know when they will have cash available to invest in inventory.
- Plan your supply chain: Planning your inventory is essential to anticipate increases in the demands of customers.
- Prepare for the future: Demand forecasting can help an organization prepare better for future shocks, such as natural disasters or new competitors.
Demand forecasting is a critical element of any organization’s business processes on which the strategic and operational plans are based. Demand forecasts can influence any short- to long-term aspects of an organization’s activities, including strategic planning, budgeting, supply planning, and network balancing. Its importance justifies organizations treating it as a critical business planning process that should be improved over time.