CHAPTER 4MARKET AND DEMAND ANALYSIS OUTLINE Situational analysis and specification of objectives Collection of secondary information Conduct of market survey Characterisation of the market Demand forecasting Uncertainties in demand forecasting Market planning Key Steps in Market and Demand Analysis and their Inter-relationships Collection of Secondary Information Situational Analysis and Specification of Objectives Demand Forecasting Characterisation of the Market Conduct of Market Survey Market Planning .Situational Analysis In order to get a “feel” of the relationship between the product and its market. and practices of the middlemen. the project analyst may informally talk to customers. he may look at the experience of the company to learn about the preferences and purchasing power of customers. Wherever possible. competitors. and others in the industry. actions and strategies of competitors. middlemen. It indicates what is known and often provides leads and cues for gathering primary information required for further analysis. .Collection of Secondary Information Secondary information is information that has been gathered in some other context and is readily available. Secondary information provides the base and the starting point for the market and demand analysis. accuracy.Evaluation of Secondary Information While secondary information is available economically and readily (provided the market analyst is able to locate it). and relevance for the purpose under consideration must be carefully examined. The market analyst should seek to know: Who gathered the information? What was the objective? When was the information gathered? When was it published? How representative was the period for which the information was gathered? Have the terms in the study been carefully and unambiguously defined? What was the target population? How was the sample chosen? How representative was the sample? How satisfactory was the process of information gathering? What was the degree of sampling bias and non-response bias in the information gathered? What was the degree of misrepresentation by respondents? . its reliability. It needs to be supplemented with primary information gathered through a market survey. though useful. The market survey may be a census survey or a sample survey. .Market Survey Secondary information. typically it is the latter. often does not provide a comprehensive basis for market and demand analysis. Information Sought in a Market Survey The information sought in a market survey may relate to one or more of the following: Total demand and rate of growth of demand Demand in different segments of the market Income and price elasticities of demand Motives for buying Purchasing plans and intentions Satisfaction with existing products Unsatisfied needs Attitudes toward various products Distributive trade practices and preferences Socio-economic characteristics of buyers . Recruit and train the field investigators. 4.Steps in a Sample Survey Typically. 7. Analyse and interpret the information. Scrutinise the information gathered. 3. a sample survey involves the following steps: 1. Define the target population. Select the sampling scheme and sample size. 2. 5. . Obtain information as per the questionnaire from the sample of respondents. Develop the questionnaire. 6. Characterisation of the Market Based on the information gathered from secondary sources and through the market survey. the market for the product/service may be described in terms of the following: • Effective demand in the past and present • Breakdown of demand • Price • Methods of distribution and sales promotion • Consumers • Supply and competition • Government policy . The important causal methods are : Chain ratio method Consumption level method End use method Leading indicator method Econometric method . quantitative manner. The important qualitative methods are : Jury of executive method Delphi method II Time Series Projection Methods : These methods generate forecasts on the basis of an analysis of the historical time series .Methods of Demand Forecasting I Qualitative Methods : These methods rely essentially on the judgment of experts to translate qualitative information into quantitative estimates. causal methods seek to develop forecasts on the basis of cause-effect relationships specified in an explicit. The important time series projection methods are : Trend projection –method Exponential smoothing method Moving average method III Causal Methods : More analytical than the preceding methods. Jury of Executive Opinion Method This method involves soliciting the opinion of a group of managers on expected future sales and combining them into a sales estimate Pros • It is an expeditious method • It permits a wide range of factors to be considered • It appeals to managers Cons • The biases cannot be unearthed easily • Its reliability is questionable . The responses received from the experts are summarised without disclosing the identity of the experts. 3. The process may be continued for one or more rounds till a reasonable agreement emerges in the view of the experts. and sent back to the experts. along with a questionnaire meant to probe further the reasons for extreme views expressed in the first round. 2. The steps involved in this method are : 1. . A group of experts is sent a questionnaire by mail and asked to express their views.Delphi Method This method is used for eliciting the opinions of a group of experts with the help of a mail survey. Pros • It is intelligible to users • It seems to be more accurate and less expensive than the traditional face-to-face group meetings Cons There are some question marks: What is the value of the expert opinion? What is the contribution of additional rounds and feedback to accuracy? . Linear relationship : Yt = a + bT Exponential relationship : Yt = aebt Polynomial relationship : Yt = a0 + a1t + a2t2 …….Trend Projection Method The trend projection method involves (a) determining the trend of consumption by analysing past consumption statistics and (b) projecting future consumption by extrapolating the trend.an tn Cobb Douglas relationship : Yt = atb . In general Ft+1 = Ft + et (4. Ft+1. Ft+1 is set lower than Ft.7) where Ft + 1 = forecast for year t + 1 α = smoothing parameter (which lies between 0 and 1) et = error in the forecast for year t = St - Ft . Ft . If Ft> St . forecasts are modified in the light of observed errors.Exponential Smoothing Method In exponential smoothing. If the forecast value for year t. is set higher than Ft. St. is less than the actual value for year t. the forecast for the year t+1. Moving Average Method As per the moving average method of sales forecasting. In symbols. the forecast for the next period is equal to the average of the sales for several preceding periods. St + St-1 + … + St-n+1 Ft+1 = (4.8) n where Ft+1 = forecast for the next period St = sales for the current period n = period over which averaging is done . 7 million units Proportion of non-decaffeinated coffee used at home : 0.400 Instant non-decaffeinated coffee used at home : 54. the General Foods of the U. in the following manner : Total amount of coffee sales : 174. S estimated the potential sales for a new product.835 Coffee used at home : 145.5 million units Proportion of coffee used at home : 0.37 million units . For example.Chain Ratio Method The potential sales of a product may be estimated by applying a series of factors to a measure of aggregate demand.08 Potential sales of Maxim : 4.5 million units Proportion of instant coffee : 0.937 Non-decaffeinated coffee used at home : 136.6 million units Estimated long-run market share for Maxim : 0. a freeze-fried instant coffee (Maxim). the important ones being the income elasticity of demand and the price elasticity of demand.Consumption Level Method The method estimates consumption level on the basis of elasticity coefficients. . 020 . What is the income elasticity of demand? The income elasticity of demand is : 55 – 50 1.81 .Income Elasticity of Demand The income elasticity of demand reflects the responsiveness of demand to variations in income.000 + 1.000 and I2 = 1.020 EI = x = 4. Example The following information is available on quantity demanded and income level: Q1 = 50 . It is measured as follows : Q2-Q1 I1 + I2 EI = x (4. I1 = 1.9) I2 –I1 Q2 +Q1 where EI = income elasticity of demand Q1 = quantity demanded in the base year Q2 = quantity demanded in the following year I1 = income level in the base year I2 = income level in the following year. Q2 = 55 . 000.000 – 10.000.37 . P2 = Rs. 800.600. What is the price elasticity of demand? The price elasticity of demand is : 9.000 Ep = 600 + 800 x = . Q2 = 9.10) P2 – P1 Q2 + Q1 where Ep = price elasticity of demand Q1 = quantity demanded in the base year Q2 = quantity demanded in the following year P1 = price per unit in the base year P2 = price per unit in the following year Example The following information is available about a certain product : P1= Rs.0. It is defined as : Q2 – Q1 P1 + P2 Ep = x (4.Price Elasticity of Demand The price elasticity of demand measures the responsiveness of demand to variations in price. Q1 = 10. and the projected demand for Indchem as shown in the following slide. Project the output levels for the consuming industries. Derive the demand for the product. involves the following steps: 1. Indchem is used by four industries Alpha. 3. Project Demand for Indchem This method may be illustrated with an example. Identify the possible uses of the product. Gamma. Define the consumption coefficient of the product for various uses. The consumption coefficients for these industries.End Use Method Suitable for estimating the demand for intermediate products. Beta. the end use method. the projected output levels for these industries for the year X. A certain industrial chemical. 2. also referred to as the consumption coefficient method. 4. . and Kappa. 000 30.2 10.000 * This is expressed in tonnes of Indchem required per unit of output of the consuming industry .000 18.000 Total 69.000 Kappa Gamma 0.Consumptio Projected n Output in year Coefficient * X Projected Demand for Indchem in year X Alpha Beta 2.5 20.8 0.000 20.0 1.000 15.000 16.000 15. is the sales in period t. the Bass diffusion model seeks to estimate the pattern of sales growth for new products. It can be regarded as a network effect. According to a linear approximation of the model: nt = pN + ( q – p ) Nt-1 + ( q / N ) x ( Nt-1 )2 where nt.1 Developed by Frank Bass. It reflects the tendency of a potential customer to buy the product because many others have bought it. p is the coefficient of innovation. . N is the potential size of the market. It reflects the likelihood that a potential customer would adopt the product because of its innovative features.Bass Diffusion Model . q is the coefficient of imitation. in terms of two factors: p : The coefficient of innovation. q : The coefficient of imitation. and Nt is the accumulative sales made until period. 08 / 1. we get the following estimates of sales in year 1 and year 2.03 x 1.030 and q = 0.000 n2 = 0.2 A new product has a potential market size of 1.080 describe the industry sales of this older product.03 x 1.000.000. There is an older product that is similar to the new product. Applying the Bass diffusion model. The sales trend of the new product is expected to be similar to the older product. 0.08 – 0.000 + (0.08 – 0.000 + (0.000.080 n1 = 0.000) x (30.000.000 1.Bass Diffusion Model . p = 0.000.000) 2 = 31.000.572 .03) x + x 0 2 = 30.03) x 30.000 + (0. Hence. the lagging variables.Leading Indicator Method Leading indicators are variables which change ahead of other variables. Its limitations are that it may be difficult to find appropriate leading indicator(s) and the lead-lag relationship may not be stable over time.(ii) Second. the change in the level of urbanisation ( a leading indicator) may be used to predict the change in the demand for air conditioners (a lagging variable) Two basic steps are involved in using the leading indicator method: (i) First. The principal merit of this method is that it does not require a forecast of an explanatory variable. establish the relationship between the leading indicator(s) and the variable to be forecast. . For example. observed changes in leading indicators may be used to predict the changes in lagging variables. identify the appropriate leading indicator(s). Two types of econometric models are employed: the single equation model and the simultaneous equation model . The primary objective of econometric analysis is to forecast the future behaviour of the economic variables incorporated in the model.Econometric Method An econometric model is a mathematical representation of economic relationship(s) derived from economic theory. one-way causality is postulated.11) where Dt = demand for a certain product in year t Pt = price for the product in year t Nt = income in year t .Single Equation Model The single equation model assumes that one variable. is influenced by one or more independent variables (also referred to as the explanatory variables). In other words. the dependent variable (also referred to as the explained variable). An example of the single equation model is given below: Dt = a0 + a1 Pt + a2 Nt (4. Simultaneous Equation Model The simultaneous equation model portrays economic relationships in terms of two or more equations. GNPt = Gt + It + Ct It = a0 + a1 GNPt Ct = b0 + b1 GNP1 (4.14) where GNPt = gross national product for year t Gt = governmental purchases for year t It = gross investment for year t Ct = consumption for year t . Consider a highly simplified threeequation econometric model of Indian economy.12) (4.13) (4. Improving Forecasts You can improve forecasts by following some simple guidelines: • Check assumptions • Stress fundamentals • Beware of history • Watch out for euphoria • Don’t be dazzled by technology • Stay flexible . Uncertainties in Demand Forecasting Demand forecasts are subject to error and uncertainty which arise from three principal sources: • Data about past and present market • Methods of forecasting • Environmental change . Critically evaluate the assumptions of the forecasting methods and choose a method which is appropriate to the situation. Conduct analysis with data based on uniform and standard definitions. along the following lines. and relationships. influences. ignore the abnormal or out-of- the- ordinary observations. Adjust the projections derived from quantitative analysis in the light of unquantifiable. coefficients. may be made to cope with uncertainties. Consider likely alternative scenarios and their impact on market and competition. . In identifying trends. but significant.Coping with Uncertainties Given the uncertainties in demand forecasting. adequate efforts. Monitor the environment imaginatively to identify important changes. Conduct sensitivity analysis to assess the impact on the size of demand for unfavourable and favourable variations of the determining factors from their most likely levels. Market Planning A marketing plan usually has the following components: • Current marketing situation • Opportunity and issue analysis • Objectives • Marketing strategy • Action programme . (ii) collection of secondary information. Secondary information is information that has been gathered in some other context and is already available. information may be obtained from secondary and /or primary sources. Secondary information. though useful. It needs to be supplemented with primary information gathered through a market survey. it should be carried out in an orderly and systematic manner. The key steps in such analysis are (i) situational analysis and specification of objectives. that is likely to be a sample survey. For purposes of market study. often does not provide a comprehensive basis for market and demand analysis.SUMMARY Given the importance of market and demand analysis. (iii) conduct of market survey. (iv) characterisation of the market. its reliability. The project analyst may do an informal situational analysis which in turn may provide the basis for a formal study. and relevance for the purpose under consideration must be carefully examined. accuracy. While secondary information is available economically. (v) demand forecasting and (vi) market planning. specific to the project being appraised. . . Based on the information gathered from secondary sources and through market survey. and causal methods. (vii) Analyse and interpret the information. the market for the product/service may be described in terms of the following: effective demand in the past and present. breakdown of demand. A wide range of forecasting methods is available to the market analyst. time series projection methods. (iii) Develop the questionnaire. (iv) Scrutinise the information gathered. supply and competition. viz. The important qualitative methods are : Jury of executive method and Delphi method. These may be divided into three broad categories. an attempt may be made to estimate future demand. consumers. methods of distribution and sales promotion. After gathering information about various aspects of the market and demand from primary and secondary sources. and government policy. Typically. a sample survey consists of the following steps: (i) Define the target population (ii) Select the sampling schemes and sample size. price. Qualitative methods rely essentially on the judgment of experts to translate qualitative information into quantitative estimates. qualitative methods.. and service. The important causal methods are: chain ratio method. promotion. end use method. To enable the product to reach a desired level of market penetration. covering pricing. and econometric method. leading indicator method. quantitative manner. . Causal methods seek to develop forecasts on the basis of cause-effect relationships specified in an explicit. consumption level method. distribution. needs to be developed. a suitable marketing plan.