Risk, Uncertainty, and Accuracy
Risk and uncertainty are central to forecasting and prediction; it is generally considered good practice to indicate the degree of uncertainty attached to specific forecasts. In any case, the data must be up to date in order for the forecast to be as accurate as possible. In some cases, the data used to predict the variable of interest is itself forecasted (Wikipedia, 2019).
Accuracy is important when it comes to forecasts. If executives overestimate the demand for a product, the company could end up spending money on manufacturing, distribution, and servicing activities it won’t need.
Underestimating demand can be just as devastating. When a company introduces a new product, it launches marketing and sales campaigns to create demand for it. But if the company isn’t ready to deliver the amount of the product the market demands, then other competitors can steal sales the firm might otherwise have captured. Sony’s inability to deliver the e-Reader in sufficient numbers made Amazon’s Kindle more readily accepted in the market; other features then gave the Kindle an advantage that Sony is finding difficult to overcome.
The firm has to do more than just forecast the company’s sales. The process can be complex, because how much the company can sell will depend on many factors such as how much the product will cost, how competitors will react, and so forth. Each of these factors has to be taken into account in order to determine how much the company is likely to sell. As factors change, the forecast has to change as well. Thus, a sales forecast is actually a composite of a number of estimates and has to be dynamic as those other estimates change.
Market Potential and Sales Potential
A common first step is to determine market potential, or total industry-wide sales expected in a particular product category for the time period of interest. (The time period of interest might be the coming year, quarter, month, or some other time period.) Some marketing research companies, such as Nielsen, Gartner, and others, estimate the market potential for various products and then sell that research to companies that produce those products.
Once the firm has an idea of the market potential, the company’s sales potential can be estimated. A firm’s sales potential is the maximum total revenue it hopes to generate from a product or the number of units of it the company can hope to sell. The sales potential for the product is typically represented as a percentage of its market potential and equivalent to the company’s estimated maximum market share for the time period. In your budget, you’ll want to forecast the revenues earned from the product against the market potential, as well as against the product’s costs.
“3. Forecasting” from Introduction to Operations Management by Mary Drane and Hamid Faramarzi is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License, except where otherwise noted.