Demand/Sales Forecasting in Indian Firms

Abhijeet Kamble (05329031) Ajay Nalawade (05329007) Ashutosh Deo (05329003) Sagar Ranadive (05329006) April 3, 2006

Abstract Forecasting is a science of predicting the future by analyzing the previous data. The science of forecasting helps rms to take strategic decisions to achieve their goals. Therefore, there is a need for precision in the demand forecasts. This has led to development of various new tools and methods for forecasting in the last two decades. This report discusses the forecasting methods used for prediciting demand/sales of Indian rms. We also present a case study on two-wheeler Indian automotive industry.

Introduction

Forecasting implies predicting the future after studying and analysing the past and present data. Forecasting is of special importance in industries, where important strategic decisions need to be taken to optimize the eciency of the resources and hence maximize the prots.

Sales Forecasting

The forecasting of sales is one of the most important information tools for every management. In a company lot of units use the sales forecast for example top management, nance, production, human resources, purchasing and marketing units. Top management unit allocates resources among functional areas and to control operations inside and outside of the company by using the sales forecast. The companys nance unit uses the sales forecasting to decide on capital appropriation, to project cash ows, and to establish operating budgets. Production uses it to decide how much the company has to produce and in what time and to control inventories. Human resource units use the sales forecasting (to plan personnel requirements and also as an input in collective bargaining). Purchasing unit uses it to plan how much 1

materials the company needs and in which part of the year/month/week or even day. Marketing units of rms nd sales forecasting very useful (to plan marketing and sales programs and to allocate resources among the various marketing activities). The meaning of sales forecasting grows as rms start to coordinate their own bussines in a world wide scale. The bussiness world knows two types of sales forecasting methods and they are subjective methods and objective methods, all of them have advantages and disadvantages. Usually decision makers use one or another forecasting method and their decision will depend on technical knowledge, previous sales data, and for what exactly the sales forecasting will be used.

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3.1

Methods of sales forecasting

Qualitative Methods

Qualitative Forecasts consider the range of factors which inuence the demand. These factors are then ranked in order of importance and each of them in turn is analyzed to reveal future trends. Qualitative methods of forecasting are: consumer expectations, sales force composite, jury of executive opinion and Delphi technique. 3.1.1 Consumer Expectations

Consumers are frequently interviewed with the help of questionnaires concerning their buying habits, motives and intentions. The consumer feedback is used to estimate the expected consumption or purchases of the product. This method has following advantages: Forecast estimates straight from buyers. Information about projected product can be very detailed. Insights give assistance in planning the market strategy. Practical for forecasting new-products. Disadvantages of this sales forecasting method are: Company has to choose potential customers carefully and the number of customers has to be small. Works well with business to business goods, but not with consumer goods. Depends on how precisely the users make their evaluations. Takes a lot of money, time and labour. 2

3.1.2

Delphi technique

If a more accurate forecast is wanted from a group of experts and the eects of group dynamics has to be controlled, then a good technique to use is Delphi technique. Delphi is based on iterative approach and it uses anonymous repeated feedback. The people involved in the feedback give their own forecast about the subject and the feedbacks are gathered into a summary. The forecast is made with the available knowledge the person has. The summary lists the median of each forecast gure. Also a summary of the speard of estimates is put into the summary. If someones answer diers a lot from the median, then the person gives an explanation why she or he made such and estimate. The explanation is added into the summary and the summary is given to all the participants of the forecast. They study the summary and make a new forecast. These steps are repeated several times in the idea that repeated measurements will lessen the range of estimates and they will come together to a correct or true answer. The advantages of Delphi are: The eects of group dynamics is reduced Statistical information can be used The disadvantages are: Can take a long time and is money consuming

3.2

Objective methods

Objective methods are those that use well-specied processes to analyze the data. Ideally, they have been specied so well that other researchers can replicate them and obtain the same forecasts. These have also been called explicit, statistical or formal methods. These methods usually rely on quantitative analytical approaches in developing the forecast. 3.2.1 Market test

Company does the market test by placing a product in a few representative geographic areas to understand how well it performs and then projecting that experience to the whole market. Usually companies do this test for a new or improved version of an old product. Advantages of this forecasting method are: The method gives the best understanding of consumers reaction to the product. The method permits evaluation of the success of the total marketing program. 3

 Has a good use for new and innovative products. The disadvantages are: Competitors of the company can easily nd out what is going on. Competitors start to do something about their products. Market tests takes lots of money and time. Often takes a long time to measure the exact level of initial and repeat demand. 3.2.2 Time-series analysis

A company can use dierent time-series analysis methods for forecasting sales. Time-series analysis makes a forecast for the future sales on the base of historical data. The diculty and style of these analyses can dier extensively. The most easy assessment might use last years gures as the next years forecast, but if the company is new or is a growing company, then this easy method cannot be used. 3.2.3 Moving average

Moving average is a quite simple method of sales forecasting, it considers the previous years sales to be the forecast for the next year. Using this method can lead to large errors if there is much variation in sales from one year to the next. By using some kind of average of recent values, it is possible to not care about the randomness of sales from one year to the other. For example, company might average the last two years sales, the last three years sales, or any number of other periods. The forecast would simply be the average that resulted. The number of observations included in the average is typically determined by trial and error. Diering numbers of periods are tried, and number of periods that produce the most accurate forecasts of the trial data is used to develop the forecast model. Once determined, it remains constant. 3.2.4 Exponential smoothing

Exponential smoothing is a type of moving average. However, instead of weighing all observations equally in generating the forecast, exponential smoothing weighs the most recent observations heaviest, for good reason. The most recent observations contain the most information about what is likely to happen in the future, and they should logically be given more weight.

3.2.5

Decomposition method

The Decomposition method of sales forecasting is typically applied to monthly or quarterly data where seasonal pettern is evident and the manager wishes to forecast sales not only for the year but also for each period in the year. It is important to determine what portion of sales changes represents an overall, fundamental change in demand and what portion is due to seasonality in demand. The decomposition method attempts to isolate four separate portions of a time series: the trend, cyclical, seasonal and random factors. In using the decomposition method, the analyst typically rst determines the seasonal pattern and removes its impact to identify the trend. Then the cyclical factor is estimated. After the three components are isolated, the forecast is developed by applying each factor in turn to the historical data. The advantages are: Utilizes historical data. Objective, inexpencive. Disadvantages are: Not useful for new or innovative products. Factors for trend, cyclical, seasonal, or product life-cycle phase must be accurately assessed and included. Technical skill and good judgement required. Final forecast dicult to break down into individual territory estimates. Ignores planned marketing eort. 3.2.6 Panel Regression

A regression which includes both cross sectional and time series data. Panel regressions are used when one wishes to explain dierences across observations in a single period, but there are not enough observations in a single period to generate reliable results. Thus one or more cross sections from additional time periods are added to enlarge the sample. Panel regression methods may handle models in which the dependent variable is continuous, discrete, limited, or based on counts.

Case Study of Indian Two-wheeler Automotive Industry

Automobile is one of the largest industries in the global market. Being the leader in product and process technologies in the manufacturing sector, it 5

has been recognised as one of the drivers of economic growth. During the last decade, well directed eorts have been made to provide a new look to the automobile policy for realising the sectors full potential for the economy. Two-wheeler segment is one of the most important components of the automobile sector. The two-wheeler industry has been in existence in India since 1955. It consists of three segments viz. scooters, motorcycles and mopeds. According to the gures published by Society of Indian Automobile Manufacturers (SIAM), the share of two-wheelers in automobile sector in terms of units sold was about 80 per cent during 2003-04. This high gure itself is suggestive of the importance of the sector.

4.1

Growth Perspective

The composition of the two-wheeler industry has witnessed major changes in the post-reform period. In 1991, the share of scooters was about 50 per cent of the total 2-wheeler demand in the Indian market. Motorcycle and moped had been experiencing almost equal level of shares in the total number of two-wheelers. In 2003-04, the share of motorcycles increased to 78 per cent of the total two-wheelers, while the shares of scooters and mopeds declined to the level of 16 and 6 per cent respectively. A clear picture of the motorcycle segments gaining importance during this period is exhibited by the Figures 1, 2 and 3 depicting total sales, share and annual growth during the period 1993-94 through 2003-04.

4.2

Demand Forecast

Estimations were based on Panel Regression, which takes into account both time series and cross section variation in data. A panel data of 16 major states over a period of 5 years ending 1999 was used for the estimation of parameters. The models considered a large number of macro-economic, demographic and socio-economic variables to arrive at the best estimations for dierent two-wheeler segments. The projections have been made at all India and regional levels. Dierent scenarios have been presented based on dierent assumptions regarding the demand drivers of the two-wheeler industry. The most likely scenario assumed annual growth rate of Gross Domestic Product (GDP) to be 5.5 per cent during 2002-03 and was anticipated to increase gradually to 6.5 per cent during 2011-12. The all-India and regionwise projected growth trends for the motorcycles and scooters are presented in Table 1. The above-mentioned forecast presents a long-term growth for a period of 10 years. The high growth rate in motorcycle segment at present is forecast to stabilise after a certain point beyond which a condition of equilibrium

will set the growth path. Table 1 suggests two important dimensions for the two-wheeler industry. The region-wise numbers of motorcycle and scooter suggest the future market for these segments. At the all India level, the demand for motorcycles will be almost 10 times of that of the scooterst, the same in the western region will be almost 20 times. It is also evident from the table that motorcycle will nd its major market in the western region of the country, which will account for more than 40 per cent of its total demand. The south and the north-central region will follow this. The demand for scooters will be the maximum in the northern region, which will account for more than 50 per cent of the demand for scooters in 2011-12. 7

2-Wheeler Segment Motorcycle Scooter

South 2835 (12.9) 203 (2.6)

West 4327(16.8) 219 (3.5)

Regions North-central 2624 (12.5) 602 (2.8)

East and North-east 883 (11.1) 99 (2.0)

All India 10669 (14.0) 1124 (2.08)

Table 1: Demand Forecast for Motorcycles and Scooters for 2011-12

4.3

Conclusion

There is a large market in semi-urban and rural areas of the country. Any strategic planning for the two-wheeler industry needs to identify these markets with the help of available statistical techniques. Potential markets can be identied as well as prioritised using these techniques with the help of secondary data on socio-economic parameters. For the two-wheeler industry, it is also important to identify the target groups for various categories of motorcycles and scooters. With the formal introduction of secondhand car market by the reputed car manufacturers and easy loan availability for new as well as used cars, the two-wheeler industry needs to upgrade its market information system to capture the new market and to maintain its already existing markets. Availability of easy credit for two-wheelers in rural and smaller urban areas also requires more focussed attention. It is also imperative to initiate measures to make the presence of Indian two-wheeler industry felt in the global market. Adequate incentives for promoting exports and setting up of institutional mechanism such as Automobile Export Promotion Council would be of great help for further surge in demand for the Indian two-wheeler industry.

References
[SCOTT] Long Range Forecasting From Crystal Ball To Computer; J.Scott Armstrong; A Wiley Interscience Publication. [FADA] Federation of Automobile Dealers http://www.fadaweb.com/home.htm Associations of India.

[MOTE] Managerial Economics: Concepts and Classes; Mote et al.;Tata McGraw-Hill Publications;1985