Only when you fully appreciate the microeconomic context in which your firm operates and with which it interacts will you have the depth of understanding one which to build a robust strategy. There are two distinct but interrelated aspects of microeconomic behavior to grasp: market demand and industry supply. The latter deals with the forces driving industry competition and their impart on market share, pricing and profitability in your industry.
The following are a few tools to forecasting:
Sizing and Market-crafting (Evans):
The Tool: Size matters: Without market size you won't know market share. Without market share, you'll find it hard to judge competitive position. The larger your company, the easier it is to find data on market size. Industry association proliferate and many either compute market share themselves or contract out the job to specialist market research firms.
How to use it: First you must decide what you are looking for: your addressed market or your addressable market. The difference can be huge:
- Adressed market - those to whom you currently offer your goods or services and who may or may not purchase them.
- Addressable (or available) market - all those whom you could serve should you extend your offering.
There are six main ways of sizing a market:
- Top-down market research - start with a known, researched market size and chop out inapplicable sections, or make appropriate assumptions on relevant proportions, to drill down to the target market.
- Bottom-up market research - take disaggregated data from a market research report and assemble the relevant bits that make up your target market.
- Bottom-up customer sizing - estimate how much each major customer spends in the target market and make an allowance for other, minor customers.
- Bottom-up competitor sizing/marketcrafiting - estimate the scale of your competitors in the target market.
- Related market triangulation - use two, three or more known sizes of related markets to gauge a rough estimate on the target market.
- Final triangulation - juggle the estimates from the above sources and subject them to sanity checks; consider giving each estimate a reliability rating, work out relative probabilities and compute a weighted average estimate of target market size.
Market-crafting is one of the approaches mentioned above. There are seven main steps in market crafting:
- Select your main competitors - those you pitch regularly against, those you exhibit alongside at trade shows - and don't forget the foreign competitors, especially those from lower-cost countries.
- Take competitor A: do you think you are selling more or less than you into this market? if less, by how much less, very roughly? are they selling half as much you? three-quarters? if they sell more than you , by how much more, very roughly? 10 percent more? A third more? Is there any publicly available information which can guide you on this? - competitor A's sales to this market are unlikely to be available if it is a private company, but employment data can be indicative. What do customers tell you? And suppliers?
- Taking your current sales level as an index number of 100, assign the appropriate index number to competitor A; if you think they sell less than you in this market, but not that much less, say 10 percent less, give them an index number of 90.
- Repeat steps 2 and 3 each of the competitors named in step 1.
- Make an allowance for any other competitors you have not names, those who are small or those who only appear now and gain; this should also be an index number; if you think all these others together sell about half what you sell to the market, give this 'Other' category an index number of 50.
- Add up all the index numbers, divide the total by 100 and multiply by your level of sales - that is your preliminary estimate of market size.
- Ask your staff and contacts to go talk to their friends and contacts who work with the competitors and get their input to refine your estimates.
When to use it Use market crafting or other maker sizing methods whenever you have no their party data source and need to create a market size from scratch.
When to be wary: Treat the results with caution. Take another look at your numbers. Is there any way they may be right? Do they have access to information you don't? What would that imply for your share, or other competitors' shares?
The HOOF approach to demand forecasting
The Tool You have better chance of growing in a market that is prospering than in one thats shrinking. Market size is all very well, but what often matters more in strategy development is what the market is doing, where it is going - the dynamics, as opposed to the statics. Is market demand in your main business segments growing, shrinking, or flat-lining?
How to use it You need to apply these steps for each of your main business segments.
The four steps are:
- Historic growth - assess how market demand has grown in the past.
- Drivers past - identify what has been driving that past growth.
- Divers future - assess whether there will be any change in influence of these and other drivers in the future.
- Forecast growth - forecast market demand growth, based on the influence of future drivers.
Historic growth - This is where you need to get some facts and figures. If you have access to market research data, whether on a regular basis or with one-off purchase, all your needs should be in there. If not, you may have to do some marketcrafting. Get an average annual (compound) growth rate over a number of recent years, preferably the last three or four. If there have been ups and downs, you should smooth them out with three-year moving averages before calculating the percentage change.
One word of caution: market demand growth is generally measured, analyzed and forecast in real terms.
- In nominal terms: with goods or services priced in the money of the day.
- In real terms: the growth rate in nominal prices deflated by the growth rate in the average prices of goods in that market; as long as correct deflators are used, this growth rate should be a measure of volume growth.
Should you need to business planning and financial forecasting you must bring average price forecast back into mix. Then your revenue forecast, as well as the whole P&L, will be able to be compared directly with market growth-rate forecasts in nominal prices.
Drivers past - Once you have uncovered some information on recent market demand growth, find out what has been influencing that growth. Typical factors that influence demand in many markets are:
- Per capita income growth
- Population groth in general
- Population growth specific to a market
- Some aspect of government policy or purchasing
- Changing awareness, perhaps from high levels of promotion by competing providers
- Business structural shifts
- Price change
- Fashion, even a craze
- Weather - seasonal variations, but maybe even the longer-term effects of climate change
Drivers future - Now you need to assess how each of these drivers is likely to develop over the next few years. Are things going to carry on more or less as before a driver? Or are things going to change significantly. What are the prospects for growth in vertical or complementary sectors? The most important driver is, of course, the economic cycle. If it seems the economy is poised for a nosedive, that could have a serious impact on demand in your business over the next year or two - assuming your business is relatively sensitive to the economic cycle or maybe is relatively inelastic.
Forecast growth - Make sure all drivers are taken into account, irrespective of whether hard data can be found on them. The HOOF process encourages you to seek out all relevant drivers and assess their influence in a structured, combined quantitative and qualitative context.
When to use it: Whenever you need to forecast market demand.
When to be wary: Take care to identify all relevant drivers. Use whatever evidence you can muster dashed by a strong dose of reasoned judgement, in assessing their influence on demand growth, past, present and future. And be wary when computing historic growth rates.
Smoothing the moving averages
The Tool: Where markets have been up and down, showing no consistent trend, take care. Approach to demand forecasting. The best way to deal with the market volatility is to plot a graph on logarithmic paper and draw a line of best fit through the points. Plotting data on logarithmic scale can be challenging for some.
A simple non graphical alternative is to translate the data into moving averages. This enables annual fluctuations to be smoothed out, making it easier to decipher and calculate trend growth rates.
How to use it: Take the set of market data and apply these steps:
When to use it: Use it when historic market size data show ups and downs or an irregular pattern.
When to be wary: Don't just compute the numbers blindly. Try to understand what was happening in each of the years to produce such irregular numbers. That will help you avoid the trap of selecting a boom year as the starting point and a bust year as the end-point. Taking boom to boom, bust to bust, average to average period should give you similar answers, but mixing them up can be severely misleading (and is much-loved reuse of the politician! :) )
A simple non graphical alternative is to translate the data into moving averages. This enables annual fluctuations to be smoothed out, making it easier to decipher and calculate trend growth rates.
How to use it: Take the set of market data and apply these steps:
- Observe the length of the cycle and select an appropriate time period for smoothing, often a three-year period.
- Take the annual average of values during that time period around any given year.
- Calculate compound growth rates between appropriate start and end points to establish the trend.
Or simply put, the sum of each year's plus the previous year's number plus the following year's number, divided by three.
When to use it: Use it when historic market size data show ups and downs or an irregular pattern.
When to be wary: Don't just compute the numbers blindly. Try to understand what was happening in each of the years to produce such irregular numbers. That will help you avoid the trap of selecting a boom year as the starting point and a bust year as the end-point. Taking boom to boom, bust to bust, average to average period should give you similar answers, but mixing them up can be severely misleading (and is much-loved reuse of the politician! :) )
Income elasticity of demand
The Tool: Income elasticity of demand ('IED'). It is a measure of how demand for good (or service) changes in relation to change in the income of customers. It is defined as the percentage change in demand divided by the percentage change in income.
If your business, or one of your product/market segments, addresses a market which is large and generic, you may be able to use IED in your market demand forecasting.
How to use it: If your market is a whole sector or sub-sector, you may well find an estimate of IED for that sector on the web. To forecast market demand you:
When to use it: Use it when your market (or segment) is sufficiently large and homogenous to merit the calculation by some public or academic institution of its income elasticity of demand.
When to be wary: Are you sure your from addresses that whole sector market? After the process of product/market segmentation. The resultant segments tend to emerge as rather specific, both to a product or product type and to customer/end-user group, not to a whole sector market. You may need to revisit your segmentation.
If your business, or one of your product/market segments, addresses a market which is large and generic, you may be able to use IED in your market demand forecasting.
Different types of goods have different IEDs
- Normal good have positive IED
- If an IED is less than 1, the good is a necessity - demand doesn't rise much in good times, nor does it fall back too much in bad times; examples are fresh fruit and vegetables, even tobacco
- If an IED is greater than 1, the good is a superior good - people buy it aplenty in good times, but cut back in bad times; examples are books, meals out.
- If an IED is greater than 2, the good is a luxury - demand fluctuates widely between good and bad times; examples are sports cars, haute couture, holidays in Seychelles.
- If an IED is around 0, the good is inelastic or sticky - demand doesn't change much in relation to changes in income; examples are bread, baked beans
- If an IED is less than 0, the good is an inferior good - demand drops during the good times and returns in bad times: the classic examples are margarine and bus travel.
How to use it: If your market is a whole sector or sub-sector, you may well find an estimate of IED for that sector on the web. To forecast market demand you:
- extract economic forecasts from a reputable source
- multiply by the income elasticity of demand.
When to use it: Use it when your market (or segment) is sufficiently large and homogenous to merit the calculation by some public or academic institution of its income elasticity of demand.
When to be wary: Are you sure your from addresses that whole sector market? After the process of product/market segmentation. The resultant segments tend to emerge as rather specific, both to a product or product type and to customer/end-user group, not to a whole sector market. You may need to revisit your segmentation.
Survey methods of demand forecasting
The Tool: There are a number of survey based methods for forecasting demand which you may find pertinent to your strategy development process:
How to use it
When to use it: Use them when you feel that canvassing of others' views would improve the ragout of demand forecasting.
When to be wary: All forecasting is based on quality of data collection and sources of data. Thus it cannot be relied on completely.
- Survey of customers' intents
- The salesforce estimation method
- The Delphi method
- Pilot test marketing
How to use it
- Survey of customers' intentions: This is where you chose a representative sample of customers from each major product/market segment and call them up. You ask them what volumes of product they are intending to buy over the next 12,24 months, not from you, but from all competitive suppliers. This can be part of the same survey you will be carrying out to colic it customer views on purchasing criteria and their rating of your firms performance and those of your rivals against those criteria. But you should not expect spectacular results. Better to accept limited expectations from the outset and tack these questions on to your survey of purchasing people at your customers - which is a necessary, not an optional, component of your strategy development process.
- Salesforce estimation method: Arrange a debate of participants who are a group of key sales people and debate where they believe market demand is heading. You act as orchestrator and assemble the accumulated opinion of the group. Salespeople get close to their customers and can often be prescient in forecasting a sales stream from their customers. But find it difficult to step back and see the market as a whole - all customers to all suppliers. They spend so much of their lives with each of a handful of trees that wood can become a blur to some.
- The Delphi method: It is a structured analysis of independent, informed, 'Apollonian' opinion. You reach out to a bunch of reputable, even 'expert' industry observers and ask them a few carefully worded questions on market demand prospects. You collate the replies, but anonymously, and return a summary of the findings to the observers. They look at what others are saying and have the option of sticking to their initial answers or modifying them, with appropriate justification. You amend this summary accordingly and there is your demand forecast, a balanced assessment of the combined wisdom of a handful of Delphic oracles.
- This is most appropriate where you are introducing a new product or venturing into a new product/market segment. Yours may be a new product or service designed to convey a customer benefit not previously realizable. Write down the key segment needs or product solution that address the market needs in couple of bullet points. Imagine there were many suppliers of your product or service and that the whole country is aware of its existence. What would the market size be? How does that compare with the market size for products or services not a million miles different from what you'll be offering? Does your estimate make sense?
When to use it: Use them when you feel that canvassing of others' views would improve the ragout of demand forecasting.
When to be wary: All forecasting is based on quality of data collection and sources of data. Thus it cannot be relied on completely.
Statistical methods of demand forecasting
The Tool: 'There are lies, damned lies and statistics' where the famously damning words of Mark Twain. Perhaps, but basic statistical tools may be of help in your market demand forecasting. The main and simplest ones are:
How to use it:
Trend Projection: This involves the placing of a line of best fit through points on a chart. The process is as follows:
When to use it: Use statistical methods when you suspect that the market crafting approach to demand forecasting would benefit from greater rigor, especially in the computation of pas growth rates.
When to be wary: Take care not to assume, without specified justification, that the trends, regressions or barometers observed in the past will hold true in the future.
- Trend Projection
- Regression analysis
- Barometric method (complex to summarize - better look up a good source)
How to use it:
Trend Projection: This involves the placing of a line of best fit through points on a chart. The process is as follows:
- Set out market demand data for each year.
- Plot on logarithmic graph paper, with time on the x-axis and demand on the y-axis.
- Visually place a line of best fit through the points.
- Measure the gradient of the line and that will equate to the average annual rate of growth (percentage per annum).
Continuing the line and seeing where it crosses future years on the x-axis will give you a set of market demand numbers for future years, but they may well be meaningless as forecast. They assume that future demand will be subject to exactly the same influences as in the past.
Regression Analysis: This is a statistical tool which can help you understand how market demand, a dependent variable, will vary in relation to variation in an independent variables, such as GDP or engineering output. The process is as follows:
- Set out market demand data for year.
- Set out the independent variable: for example, GDP, for each year.
- Plot on graph paper, with GSP on the x-axis and demand on the y-axis.
- Visually place a line of best fit through the points (for linear regressions).
- Measure the gradient of the line(m) and the intersect(c) with the y-axis when x=0 and the relationship between demand and GDP will be that of the standard equation, y=mx+c.
Again you need to take great care in using regression analysis for forecasting. The relationship that was evident in the past may not hold firm for the future. An other drivers may play a greater role n the future.
When to use it: Use statistical methods when you suspect that the market crafting approach to demand forecasting would benefit from greater rigor, especially in the computation of pas growth rates.
When to be wary: Take care not to assume, without specified justification, that the trends, regressions or barometers observed in the past will hold true in the future.
Forecasting market demand is crucial for businesses to plan production, manage inventory, allocate resources efficiently, and make informed strategic decisions.
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