Chapter 4

Market 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 Demand
Secondary Forecasting
Information

Situational
Analysis and Characterisation
Specification of the Market
of Objectives

Conduct of Market
Market Survey Planning
 Situational Analysis

In order to get a “feel” of the relationship between the product

and its market, the project analyst may informally talk to
customers, competitors, middlemen, and others in the industry.
Wherever possible, he may look at the experience of the company
to learn about the preferences and purchasing power of
customers, actions and strategies of competitors, and practices
of the middlemen
 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. It indicates
what is known and often provides leads and cues for
gathering primary information required for further
analysis.
 Evaluation of Secondary Information
While secondary information is available economically and readily (provided the
market analyst is able to locate it), its reliability, accuracy, 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?
 Market Survey

 Secondary information, though useful, often does not provide

a comprehensive basis for market and demand analysis. It
needs to be supplemented with primary information gathered
through a market survey.
 The market survey may be a census survey or a sample
survey; typically it is the latter
 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
 Steps in a Sample Survey
Typically, a sample survey involves the following steps:

1. Define the target population.

2. Select the sampling scheme and sample size.
3. Develop the questionnaire.
4. Recruit and train the field investigators.
5. Obtain information as per the questionnaire from the
sample of respondents.
6. Scrutinise the information gathered.
7. Analyse and interpret the information.
 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
 Methods of Demand Forecasting
I Qualitative Methods : These methods rely essentially on the judgment of experts to

translate qualitative information into quantitative estimates. 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 . 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, causal methods
seek to develop forecasts on the basis of cause-effect relationships specified in an
explicit, quantitative manner. The important causal methods are :
 Chain ratio method
 Consumption level method
 End use method
 Leading indicator method
 Econometric method
 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
 Delphi Method
This method is used for eliciting the opinions of a group of
experts with the help of a mail survey. The steps involved in
this method are :
1.  A group of experts is sent a questionnaire by mail and
asked to express their views.
2. The responses received from the experts are summarised
without disclosing the identity 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.
3. The process may be continued for one or more rounds till
a reasonable agreement emerges in the view of the
experts.
 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?
 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.
Linear relationship : Yt = a + bT
Exponential relationship : Yt = aebt
Polynomial relationship : Yt = a0 + a1t + a2t2 …….an tn

Cobb Douglas relationship : Yt = atb

 Exponential Smoothing Method
In exponential smoothing, forecasts are modified in the light of
observed errors. If the forecast value for year t, Ft , is less than
the actual value for year t, St, the forecast for the year t+1, Ft+1, is
set higher than Ft. If Ft> St , Ft+1 is set lower than Ft. In general
Ft+1 = Ft +  et (4.7)
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
 Moving Average Method

As per the moving average method of sales forecasting, the

forecast for the next period is equal to the average of the sales
for several preceding periods.
In symbols,
St + St-1 + … + St-n+1
Ft+1 = (4.9)
n
where Ft+1 = forecast for the next period
St = sales for the current period
n = period over which averaging is done
 Chain Ratio Method
The potential sales of a product may be estimated by
applying a series of factors to a measure of aggregate
demand. For example, the General Foods of the U. S
estimated the potential sales for a new product, a freeze-fried
instant coffee (Maxim), in the following manner :
     Total amount of coffee sales : 174.5million units
     Proportion of coffee used at home : 0.835
     Coffee used at home : 145.7 million units
     Proportion of non-decaffeinated coffee used at home : 0.937
     Non-decaffeinated coffee used at home : 136.5
million units
     Proportion of instant coffee : 0.400
     Instant non-decaffeinated coffee used at home : 54.6 million units
     Estimated long-run market share for Maxim : 0.08
     Potential sales of Maxim : 4.37 million units
 Consumption Level Method

The method estimates consumption level on the basis of

elasticity coefficients, the important ones being the income
elasticity of demand and the price elasticity of demand
 Income Elasticity of Demand
The income elasticity of demand reflects the responsiveness of demand to
variations in income. It is measured as follows :
Q2-Q1 I 1 + I2
EI = x (4.10)
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.
 
Example The following information is available on quantity demanded and
income level: Q1 = 50 , Q2 = 55 , I1 = 1,000 and I2 = 1,020 . What is the income
elasticity of demand? The income elasticity of demand is :
 
55 – 50 1,000 + 1,020
EI = x = 4.81
 Price Elasticity of Demand
The price elasticity of demand measures the responsiveness of demand to
variations in price. It is defined as :
Q2 – Q 1 P1 + P2
Ep = x (4.11)
P2 – P1 Q2 + Q 1
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.600, Q1 = 10,000, P2 = Rs. 800, Q2 = 9,000. What is the price elasticity
of demand? The price elasticity of demand is :
9,000 – 10,000 600 + 800
Ep = 600 – 800 x 9,000 +10,000 = - 0.37
 End Use Method
Suitable for estimating the demand for intermediate products, the end use method,
also referred to as the consumption coefficient method, involves the following steps:
1.      Identify the possible uses of the product.
2.      Define the consumption coefficient of the product for various uses.
3.      Project the output levels for the consuming industries.
4.      Derive the demand for the product.

This method may be illustrated with an example. A certain industrial chemical,

Indchem is used by four industries Alpha, Beta,Gamma, and Kappa.
 
The consumption coefficients for these industries, the projected output levels for these
industries for the year X, and the projected demand for Indchem as shown in the
following slide Projected Demand for Indchem
 Consumption Projected Output in year X Projected Demand
Coefficient * for Indchem in year X

Alpha 2.0 10,000 20,000

Beta 1.2 15,000 18,000
Kappa 0.8 20,000 16,000
Gamma 0.5 30,000 15,000
Total 69,000

*- This is expressed in tonnes of Indchem required per unit of output of the consuming industry
 Leading Indicator Method
Leading indicators are variables which change ahead of other
variables, the lagging variables. Hence, observed changes in leading
indicators may be used to predict the changes in lagging variables. For
example, 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, identify the appropriate leading indicator(s).(ii)
Second, establish the relationship between the leading indicator(s) and
the variable to be forecast.
The principal merit of this method is that it does not require a
forecast of an explanatory variable. 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.
 Econometric Method
• An econometric model is a mathematical representation of

economic relationship(s) derived from economic theory.

The primary objective of econometric analysis is to
forecast the future behaviour of the economic variables
incorporated in the model.
• Two types of econometric models are employed: the single
equation model and the simultaneous equation model
 Single Equation Model
The single equation model assumes that one variable, the dependent
variable (also referred to as the explained variable), is influenced by one
or more independent variables (also referred to as the explanatory
variables). In other words, one-way causality is postulated. An example of
the single equation model is given below:
 
Dt = a0 + a1 Pt + a2 Nt (4.12)
 
where Dt = demand for a certain product in year t
Pt = price for the product in year t
Nt = income in year t
 Simultaneous Equation Model

The simultaneous equation model portrays economic relationships in

terms of two or more equations. Consider a highly simplified three-
equation econometric model of Indian economy.
GNPt = Gt + It + Ct (4.13)
It = a0 + a1 GNPt (4.14)
Ct = b0 + b1 GNP1 (4.15)

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
 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
 Coping with Uncertainties
Given the uncertainties in demand forecasting, adequate efforts,
along the following lines, may be made to cope with uncertainties
      Conduct analysis with data based on uniform and standard
definitions.
     In identifying trends, coefficients, and relationships, ignore the
abnormal or out-of- the- ordinary observations.
     Critically evaluate the assumptions of the forecasting methods and
choose a method which is appropriate to the situation.
     Adjust the projections derived from quantitative analysis in the light
of
unquantifiable, but significant, influences.
     Monitor the environment imaginatively to identify important
changes.
     Consider likely alternative scenarios and their impact on market and
competition
     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
 Summary
  Given the importance of market and demand analysis, 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, (ii) collection of secondary
information, (iii) conduct of market survey, (iv) characterisation of the
market,
(v) demand forecasting and (vi) market planning.
  The project analyst may do an informal situational analysis which in turn may

provide the basis for a formal study.

 For purposes of market study, information may be obtained from secondary
and
/or primary sources.
 Secondary information is information that has been gathered in some other
context and is already available. While secondary information is available
economically, its reliability, accuracy, and relevance for the purpose under
consideration must be carefully examined.
 Secondary information, though useful, often does not provide a comprehensive
basis for market and demand analysis. It needs to be supplemented with
primary information gathered through a market survey, specific to the project
being appraised, that is likely to be a sample survey.
Typically, a sample survey consists of the following steps: (i) Define the target
      
   Based on the information gathered from secondary sources and through 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;
and government policy.
   After gathering information about various aspects of the market and demand from
primary and secondary sources, an attempt may be made to estimate future
demand.
A wide range of forecasting methods is available to the market analyst. These may
be
divided into three broad categories, viz., qualitative methods, time series projection
methods , and causal methods.
  Qualitative methods rely essentially on the judgment of experts to translate
qualitative
information into quantitative estimates. The important qualitative methods are :
Jury
of executive method and Delphi method.
  Time series projection methods generate forecasts on the basis of an analysis of the
historical time series. The important time series projection methods are : trend
projection methods, exponential smoothing method, and moving average method.
   Causal methods seek to develop forecasts on the basis of cause-effect relationships
specified in an explicit, quantitative manner. The important causal methods are :
chain ratio method, consumption level method, end use method, leading indicator