What Is Demand Forecasting? | A Comprehensive Guide

To remain competitive and profitable, you need to do more than stock the right products. You need to stock the right product in the right quantity and at the right time. Effective demand forecasting helps you achieve this year after year. If you’re curious about this forecasting for your business, learn what you need to know about demand forecasting and why you should make it a core part of your business planning. To help you do this, understand the different demand forecasting options and the different demand forecasting methodologies you can use for inventory prediction and demand management.

What Is Demand Forecasting?

Demand forecasting is the process of using business sales data from the past months and years to make a calculated estimate of your future customer demand for your products for a specific period of time.

For example, as an inventory manager, based on your analysis of your past sales data, key sales trends in your market and other factors, you can predict a 30% increase in the demand for your product for the next quarter. Your ability to do this — as accurately as you can — benefits your business in a number of ways. Those demand forecasting benefits include:

Better Decision Making and Planning

Demand forecasting provides you with the information you need to make better business decisions and plan for the future in terms of:

• Inventory levels to stock: You know how much of each product to stock for a specific period of time.
• Budgeting: You know the tools and workforce you need to hire to help you meet the expected demand.
• Financial planning: Demand forecasting helps you determine the cash flow you need to meet future customer demands.
• Pricing: Demand forecasting can provide you with the information to better understand the demand curve for your product and enable you to develop a competitive pricing strategy.
• Business growth plan: Proper demand forecast helps you identify opportunities for expansion in your industry and build a growth strategy to prepare for the future.

Increased Customer Satisfaction

Nothing sends your customers to your competitors more than continuously going out of stock. Demand forecasting helps you to stock the right amount of inventory to meet your customers’ expectations. This preparation increases your customers’ trust and satisfaction and makes them return to you.

Cheaper Cost of Operation

Knowing the right amount of inventory to stock ensures you do not waste your business funds on inventory holding costs. Also, demand forecasting helps you effectively allocate your business resources to help you achieve your goals and save on operating costs.

Better Supply Chain Management

Inventory forecasting provides you the information you need to match your procurement with customers’ demands. This benefit helps you build an efficient supply chain system that prepares you for any spike or decline in customers’ demand.

Better Product Stocking and Production

Proper knowledge of your customers’ demands will enable you to stock the right amount of products or raw materials in your warehouse to meet your customers’ demand for your products.

Increased Competitive Advantage

All the benefits listed above — optimum inventory level, higher customers satisfaction, more efficient operation and effective decision making — increase your competitive advantage in your industry. Those advantages can boost your overall market share and revenue.

Higher Profit Margin

Too much inventory and too little inventory can negatively impact your business. Demand forecasting helps you increase sales while reducing expenditure, losses due to backorders and wastage, therefore enabling an increase in your profit margin. Gaining a consistent customer base and potential new customers thanks to reliable stock can also help boost your profits.

Easier Assessment of Business Performance

Demand forecasts help you set business goals and provide metrics to measure your business’s performance for a specific period of time. For example, if you cannot provide the supply needed to match forecasted demand, you need to improve your supply chain and your business’s readiness to exploit opportunities.

6 Demand Forecasting Types

Varying with the duration of the forecast and the depth of data employed, there are six methods of demand forecasting:

1. Passive Demand Forecasting

Passive demand forecasting — the easiest type of demand forecast — works best for your business if you want to focus on sustainability instead of growth or expansion. Passive demand forecasting uses previous sales data to predict future customer demand without complicated statistical analysis.

This forecasting method assumes that future demands will be approximately the same as past sales. To achieve that, the passive demand forecasting model uses the same season’s data from the past to predict expected demand for the future.

For example, from sales data, an online seller of shoes can predict that the holiday demand for his shoes this year will be 1,000 shoes because last year, he sold approximately 1,000 shoes between November and December.

To use passive forecasting, you must possess accurate sales data. A history of collection in the past will help you in the present and future.

2. Active Demand Forecasting

Active demand forecasting works best for businesses or startups interested in focusing on growth and expansion. Active demand forecasting considers a wide range of factors beyond your sales data, such as:

• Marketing campaign data
• External economic trends
• Competitors’ activities
• Your supply chain
• The growth potentials in your industry

3. Short-Term Demand Forecasting

Short-term demand forecasting works best for businesses that deal in seasonal products. Short-term forecasting focuses primarily on the upcoming three months to a year ahead. This model’s most significant benefit is the ability to adjust to changes in customer demands.

4. Long-Term Demand Forecasting

The long-term demand method forecasts 12 months and beyond. Long-term demand forecasting is usually factored into your business’s long-term growth plans. Long-term demand forecasting makes aspirational projections and uses a combination of market research and sales data. The result is a map for the future rather than the more immediate answers other models offer.

5. Internal Business Forecasting

Internal business forecasting looks at your business’s internal operations and your capacity to meet your forecasted demands. It also narrows your forecasting down to the demand for your company’s product, not just the general market demand. This method also considers your supply chain efficiency, your staff and your cash flow — the different parts of your business that influence how much you can stock.

6. External Business Forecasting

External forecasting considers the impact of the external economy, market trends and industry movement on your business. If you’re looking to expand your product portfolio, enter a new market or respond to changes in your customers’ preferences, external business forecasting might be necessary.

You can use any of these demand forecasting options for your business individually or combine them. Using a combination of two or more can provide you enough information to optimize your inventory management and build a more accurate procurement strategy now and for the future.

Popular Methods of Demand Forecasting

There are six common demand forecasting options you can choose from to help you stock the right level of inventory. Those methods can fit into two categories — qualitative and quantitative.

Qualitative demand forecasting often lacks data or sales numbers, relying instead on informed opinions, and includes:

• The Delphi method: With this method, you employ an expert panel to iteratively make demand forecasts until a consensus is reached. A facilitator requests demand forecasts from a panel of forecasting experts. After receiving the forecast from each expert, the facilitator summarizes and shares everyone’s responses with the entire group anonymously and requests another prediction. The facilitator continues this iteration until a level of consensus is reached. The Delphi method hinges on the notion that decisions are better made in groups than individually.
• The sales force method: This technique relies on the notion that your salespeople are in the best position to forecast your customers’ needs and demands. Using this forecasting technique, you reach out to your salespeople and request a demand forecast from each of them. You create a summary from their forecasts and use it to make your final decision.
• The market research method: This method works great for new businesses and startups with minimal historical data. Using this method, you send questionnaires to your target customers to gather information on their preferences. This helps you target different demographics and customer segments. This technique requires care in sending the right questions, reaching out to the right customer segment and collating and interpreting the data. If done right, you’ll gain information you may not be able to gather from just your sales data.

Quantitative demand forecasting, which involves more number computation and calculations, includes:

• The sales trend method: This method works great if you possess a huge amount of historical sales data on your products. Using this method, you simply look at previous sales data to determine what to expect in the future. Ensure you consider the impact of external factors in your sales figures and work them into your projections for the future. For example, if a competitor arrived on the scene and lowered the demand for your product, you should consider it when using your previous sales data to make demand projections.
• The econometric method: The econometric method requires a lot of computations and mathematical manipulations. Econometrics mathematically determines the influence of external factors in the demand for your product. You’d create formulas that establish these relationships and use them to forecast for the future.
• The barometric method: This prediction technique uses what are known as economic indicators to determine the direction of change of your product’s demand and use these indicators to make demand forecasts. These indicators are grouped into leading, lagging and coincidental indicators. The entire essence of the barometric method is to use past and present events to predict the future.

Potential Demand Forecasting Problems to Overcome

Effective demand forecasting comes with some challenges. Knowing them before you implement forecasting practices can help you overcome them:

• Lack of clean sales data: Especially for startups or new product launches, a lack of sufficient data presented in usable formats can make demand forecasting difficult or lead to inaccurate guesses.
• Unpredictable supply chain: Without a predictable and reliable supply chain system, your demand forecast may do little in meeting your customers’ needs. A well-managed supply chain system is needed for your demand forecast to be useful and effective.
• Poor inventory control: Without real-time knowledge of your inventory level, it is possible to consistently overstock or understock.

Demand Forecasting Best Practices

Businesses of every size can benefit immensely from investing the time and resources needed to forecast customers’ demand. Whatever demand forecasting method you apply, to make the best predictions, here are best practices to follow to help you make the best business decisions and overcome the potential challenges:

• Create repeatable forecasting systems: Create a repeatable forecast system you can consistently rely on to make faster decisions.
• Determine the metrics to use and improve on them: Your business generates a lot of data. You need to determine the most important data to use in forecasting, so start small and improve as you go.
• Use data from all your sales channels: Integrate all your sales channels into one inventory management dashboard so you can have a single view of your inventory and sales level to help you make better and faster decisions. An inventory management software will help you achieve this.
• Always revise your forecasting methods: Always revise your demand forecast against actual demand to understand which forecasting method gives the most accurate prediction. You can then focus on what’s working or tweak your existing methods to get better results.
• Automate demand forecasting: Inventory management software helps you make faster inventory decisions. An effective inventory management solution helps you track your sales data from different channels and your inventory levels. It’ll also provide you an up-to-date count for all your products in one place and help you make better-informed forecasting decisions for your product.

Simplify Your Demand Forecasting With Finale Inventory

You now know how demand forecasting helps you run a more competitive and profitable inventory system for your business. With Finale Inventory, an inventory management tool, you can handle demand forecasting like a pro. Enlist Finale Inventory to eliminate the hard and manual work, save you productive hours every week and grow your business revenue and profitability.

Finale Inventory is an adaptive, lightning-fast and scalable cloud-based inventory management solution that helps you manage and track inventory across multiple warehouses. Our solution integrates with over 40 sales channels and marketplaces to bring all your sales and inventory data in one place. With this, you can easily monitor and alter production and product stocking plans based on your sales performance and turnover rate.

Our inventory management solution also provides automated restock forecasting that calculates your inventory reorder point for different products and provides the best time to request more of your products using historical sales data. This functionality helps you make better purchase decisions faster, maximize sales and customer satisfaction and minimize your cost of production and operation.