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Forecasting 101

Assessing how the future will look is one of the hardest things businesses are faced with. Though it is critical to their future success, many find this assessment very hard to do. Moreover, in an ever-changing and dynamic business environment, some argue forecasting has no real value. However, they are wrong. In order for businesses to be ready for the challenges and opportunities that the future holds, they have to adopt a forward-looking perspective. One of the main tools businesses use to obtain this perspective is forecasting. I will dedicate this post to talk about the forecasting process in companies.

I’ll start by talking about the way forecasting is combined into the company’s planning. Forecasts of the economic and business environments are critical to the strategic planning of the entire business because forecasts shed light on the opportunities and threats ahead. Product and market forecasts are crucial to the launching of a new product or entering a new market. Product and marketing plans are action oriented; they specify which resources are going to be invested in which activities. Therefore, accurate and detailed forecasts can make or break a successful product or market launch. One of the cases in which forecasting is widely used is sales and production planning. Before making an order of new products or parts, manufacturers and retailers must first predict what volume of sales they think they will be able to achieve. Guessing or estimating future sales volume may lead to large unsold and unwanted inventory and low cash flow.

The first task in the forecasting process is choosing which forecasting methods and which time period will provide the desired prediction. Also, because forecasts are usually based on past data and will be used for future analysis, it is important not to use monetary value and to use an index that is inflation free.

Forecasting methods can be divided into two major types: objective methods comprising various statistical approaches and subjective methods based on surveys of opinion. I’ll first start with the objective methods:

Historical Analogy: This method is based on the product-life-cycle philosophy. This philosophy assumes that most products face recognizable stages of youth, maturity, and decline. Analyzing the stage a certain product is in can help predict future sales and help plan changes and modification in the product to affect the product life cycle curve. Other factors such as new legislation or social and economic changes might also affect the curve; therefore, this approach is relevant to products with a short to medium life span.

Moving Averages: This method is used to understand trends while smoothing peaks and troughs in the data. Historical market and sales patterns are used to predict future ones by eliminating random errors and devotions and finding the “average” trend. This method can be skewed if used after major events or to make predictions about products in rapidly changing markets. Exponential Smoothing is a forecasting method similar to Moving Averages, but it gives recent events greater importance in the analysis.

Subjective methods include surveys of Users’ and Experts’ Opinions. These methods are less reliable, but they can certainly provide information about consumers’ tendencies and perspectives regarding their future consumption of a certain product. The main criticism about these methods is that both experienced experts’ and consumers’ views are likely to be heavily influenced by the events of the current moment and therefore provide biased responses.

Small- and micro-business owners are sometimes so overwhelmed with their day-to-day operations they never stop to think about the future. This, along with the fact that forecasting is a complex process that requires some knowledge and a lot of past data may discourage these business owners from trying to use this important tool. However, forecasting is critical to the survival of any business, small or large, and with a little effort and will, anyone can do it.

Based on: Hague, Paul. “White Paper: Forecasting & Scenario Planning.” B2B International. (2012): n. pag. Web. 31 October 2012.

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