CHAPTER 4

MARKET AND DEMAND ANALYSIS

OUTLINE
Situationalanalysisandspecificationofobjectives
Collectionofsecondaryinformation
Conductofmarketsurvey
Characterisationofthemarket
Demandforecasting
Uncertaintiesindemandforecasting
Marketplanning

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
Inordertogetafeeloftherelationshipbetweentheproductandits
market, the project analyst may informally talk to customers,
competitors,middlemen,andothersintheindustry.Whereverpossible,
he may look at the experience of the company to learn about the
preferencesandpurchasingpowerofcustomers,actionsandstrategiesof
competitors,andpracticesofthemiddlemen.

Collection of Secondary Information

Secondary information is information that has been gathered in

someothercontextandisreadilyavailable.

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
informationrequiredforfurtheranalysis.

Evaluation of Secondary Information

Whilesecondaryinformationisavailableeconomicallyandreadily(providedthemarket
analyst is able to locate it), its reliability, accuracy, and relevance for the purpose under
considerationmustbecarefullyexamined.Themarketanalystshouldseektoknow:
Whogatheredtheinformation?Whatwastheobjective?
Whenwastheinformationgathered?Whenwasitpublished?
Howrepresentativewastheperiodforwhichtheinformationwasgathered?
Havethetermsinthestudybeencarefullyandunambiguouslydefined?
Whatwasthetargetpopulation?
Howwasthesamplechosen?
Howrepresentativewasthesample?
Howsatisfactorywastheprocessofinformationgathering?
Whatwasthedegreeofsamplingbiasandnon-responsebiasintheinformation
gathered?
Whatwasthedegreeofmisrepresentationbyrespondents?

Market Survey

Secondary information, though useful, often does not provide a

comprehensivebasisformarketanddemandanalysis.Itneedstobe
supplemented with primary information gathered through a market
survey.

The market survey may be a census survey or a sample survey;

typicallyitisthelatter.

Information Sought in a Market Survey

The information sought in a market survey may relate to one or more of the
following:
Totaldemandandrateofgrowthofdemand
Demandindifferentsegmentsofthemarket
Incomeandpriceelasticitiesofdemand
Motivesforbuying
Purchasingplansandintentions
Satisfactionwithexistingproducts
Unsatisfiedneeds
Attitudestowardvariousproducts
Distributivetradepracticesandpreferences
Socio-economiccharacteristicsofbuyers

Steps in a Sample Survey

Typically,asamplesurveyinvolvesthefollowingsteps:
1. Definethetargetpopulation.
2. Selectthesamplingschemeandsamplesize.
3. Developthequestionnaire.
4. Recruitandtrainthefieldinvestigators.
5. Obtaininformationasperthequestionnairefromthe
sampleofrespondents.
6. Scrutinisetheinformationgathered.
7. Analyseandinterprettheinformation.

Characterisation of the Market

Basedontheinformationgatheredfromsecondarysourcesandthrough
themarketsurvey,themarketfortheproduct/servicemaybedescribed
intermsofthefollowing:
Effectivedemandinthepastandpresent
Breakdownofdemand
Price
Methodsofdistributionandsalespromotion
Consumers
Supplyandcompetition
Governmentpolicy

MethodsofDemandForecasting
IQualitativeMethods:Thesemethodsrelyessentiallyonthejudgmentofexpertsto

translatequalitativeinformationintoquantitativeestimates.Theimportant
qualitativemethodsare:
Juryofexecutivemethod
Delphimethod
IITimeSeriesProjectionMethods:Thesemethodsgenerateforecastsonthebasisof
ananalysisofthehistoricaltimeseries.Theimportanttimeseriesprojection
methodsare:

Trendprojectionmethod
Exponentialsmoothingmethod
Movingaveragemethod
IIICausalMethods:Moreanalyticalthantheprecedingmethods,causalmethods
seektodevelopforecastsonthebasisofcause-effectrelationshipsspecifiedinan
explicit,quantitativemanner.Theimportantcausalmethodsare:
Chainratiomethod
Consumptionlevelmethod
Endusemethod
Leadingindicatormethod
Econometricmethod

Jury of Executive Opinion Method

Thismethodinvolvessolicitingtheopinionofagroupofmanagerson
expectedfuturesalesandcombiningthemintoasalesestimate

Pros
Itisanexpeditiousmethod
Itpermitsawiderangeoffactorstobeconsidered
Itappealstomanagers

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
helpofamailsurvey.Thestepsinvolvedinthismethodare:
1.

Agroup of experts is sent a questionnaire by mail and asked to express

theirviews.

2.

The responses received from the experts are summarised without

disclosingtheidentityoftheexperts,andsentbacktotheexperts,along
withaquestionnairemeanttoprobefurtherthereasonsforextremeviews
expressedinthefirstround.

3.

The process may be continued for one or more rounds till a reasonable
agreementemergesintheviewoftheexperts.

Pros
Itisintelligibletousers
Itseemstobemoreaccurateandlessexpensivethanthe
traditionalface-to-facegroupmeetings

Cons
Therearesomequestionmarks:Whatisthevalueoftheexpertopinion?
Whatisthecontributionofadditionalroundsandfeedbacktoaccuracy?

Trend Projection Method

The trend projection method involves (a) determining the trend of
consumption by analysing past consumption statistics and (b)
projectingfutureconsumptionbyextrapolatingthetrend.
Linearrelationship

:Yt=a+bT

Exponentialrelationship

:Yt=aebt

Polynomialrelationship

:Yt=a0+a1t+a2t2.antn

CobbDouglasrelationship :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
actualvalueforyeart,St,theforecastfortheyeart+1,Ft+1,issethigher
thanFt.IfFt> St ,Ft+1issetlowerthanFt.Ingeneral
Ft+1=Ft + et

(4.7)

whereFt+1=forecastforyeart+1
=smoothingparameter(whichliesbetween0and1)
et=errorintheforecastforyeart=St-Ft

Moving Average Method

Asperthemovingaveragemethodofsalesforecasting,theforecastfor
thenextperiodisequaltotheaverageofthesalesforseveralpreceding
periods.
Insymbols,
St+St-1++St-n+1
Ft+1=

(4.8)
n

where Ft+1=forecastforthenextperiod
St =salesforthecurrentperiod
n =periodoverwhichaveragingisdone

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:
Totalamountofcoffeesales

174.5millionunits

Proportionofcoffeeusedathome

0.835

Coffeeusedathome

145.7millionunits

Proportionofnon-decaffeinatedcoffeeusedathome

0.937

Non-decaffeinatedcoffeeusedathome

136.5millionunits

Proportionofinstantcoffee

0.400

Instantnon-decaffeinatedcoffeeusedathome

54.6millionunits

Estimatedlong-runmarketshareforMaxim

0.08

PotentialsalesofMaxim

4.37millionunits

Consumption Level Method

The method estimates consumption level on the basis of elasticity
coefficients, the important ones being the income elasticity of demand
andthepriceelasticityofdemand.

Income Elasticity of Demand

Theincomeelasticityofdemandreflectstheresponsivenessofdemandtovariations
inincome.Itismeasuredasfollows:
Q2-Q1 I1+I2
EI=
x
(4.9)
I2I1 Q2+Q1

whereEI=incomeelasticityofdemand
Q1=quantitydemandedinthebaseyear
Q2=quantitydemandedinthefollowingyear
I1=incomelevelinthebaseyear
I2=incomelevelinthefollowingyear.

Example Thefollowinginformationisavailableonquantitydemandedandincome
level:Q1=50,Q2=55,I1=1,000andI2=1,020.Whatistheincomeelasticityof
demand?Theincomeelasticityofdemandis:

5550
1,000+1,020
EI=
x=4.81

Price Elasticity of Demand

Thepriceelasticityofdemandmeasurestheresponsivenessofdemandtovariations
inprice.Itisdefinedas:
Q2Q1 P1+P2
Ep=
x
(4.10)
P2P1
Q2+Q1
whereEp=priceelasticityofdemand
Q1=quantitydemandedinthebaseyear
Q2=quantitydemandedinthefollowingyear
P1=priceperunitinthebaseyear
P2=priceperunitinthefollowingyear

Example Thefollowinginformationisavailableaboutacertainproduct:
P1=Rs.600,Q1=10,000,P2=Rs.800, Q2 =9,000.Whatisthepriceelasticityof
demand?Thepriceelasticityofdemandis:
9,00010,000
Ep =

600+800
x

- 0.37

End Use Method

Suitableforestimatingthedemandforintermediateproducts,theendusemethod,also
referredtoastheconsumptioncoefficientmethod,involvesthefollowingsteps:
1.Identifythepossibleusesoftheproduct.
2.Definetheconsumptioncoefficientoftheproductforvarioususes.
3.Projecttheoutputlevelsfortheconsumingindustries.
4.Derivethedemandfortheproduct.

Project Demand for Indchem

This method may be illustrated with an example. A certain industrial chemical,
IndchemisusedbyfourindustriesAlpha,Beta,Gamma,andKappa.

Theconsumptioncoefficientsfortheseindustries,theprojectedoutputlevelsforthese
industries for the year X, and the projected demand for Indchem as shown in the
followingslide.

Consumptio
Projected
n
Output in year
Coefficient *
X

Projected
Demand for
Indchem in year
X

Alpha
Beta

2.0
1.2

10,000
15,000

20,000
18,000

Kappa
Gamma

0.8
0.5

20,000
30,000

16,000
15,000

Total
69,000
* This is expressed in tonnes of Indchem required per unit of
output of the consuming industry

Bass Diffusion Model - 1

Developed by Frank Bass, the Bass diffusion model seeks to estimate the pattern of
salesgrowthfornewproducts,intermsoftwofactors:
p:Thecoefficientofinnovation.Itreflectsthelikelihoodthatapotentialcustomer
wouldadopttheproductbecauseofitsinnovativefeatures.
q : Thecoefficientofimitation.Itreflectsthetendencyofapotentialcustomerto
buytheproductbecausemanyothershaveboughtit.Itcanberegardedasa
networkeffect.
Accordingtoalinearapproximationofthemodel:
nt=pN+(q p )Nt-1+(q /N )x(Nt-1)2
wherent,isthesalesinperiodt,pisthecoefficientofinnovation,Nisthepotentialsize
of the market, q is the coefficient of imitation, and Nt is the accumulative sales made
untilperiod.

Bass Diffusion Model - 2

Anewproducthasapotentialmarketsizeof1,000,000.Thereisanolderproductthat
issimilartothenewproduct. p = 0.030andq=0.080 describetheindustrysalesof
thisolderproduct.Thesalestrendofthenewproductisexpectedtobesimilartothe
olderproduct.
ApplyingtheBassdiffusionmodel,wegetthefollowingestimatesofsalesinyear1
andyear2.
0.080
n1=0.03x1,000,000+(0.080.03)x+x0 2=30,000
1,000,000

n2=0.03x1,000,000+(0.080.03)x30,000+(0.08/1,000,000)x(30,000) 2

=31,572

Leading Indicator Method

Leading indicators are variables which change ahead of other variables, the
laggingvariables.Hence,observedchangesinleadingindicatorsmaybeused
topredictthechangesinlaggingvariables.Forexample,thechangeinthelevel
ofurbanisation(aleadingindicator)maybeusedtopredictthechangeinthe
demandforairconditioners(alaggingvariable)
Two basic steps are involved in using the leading indicator method: (i)
First, identify the appropriate leading indicator(s).(ii) Second, establish the
relationshipbetweentheleadingindicator(s)andthevariabletobeforecast.
Theprincipalmeritofthismethodisthatitdoesnotrequireaforecastof
an explanatory variable. Its limitations are that it may be difficult to find
appropriateleadingindicator(s)andthelead-lagrelationshipmaynotbestable
overtime.

Econometric Method

Aneconometricmodelisamathematicalrepresentationofeconomic
relationship(s)derivedfromeconomictheory.Theprimaryobjective
of econometric analysis is to forecast the future behaviour of the
economicvariablesincorporatedinthemodel.

Twotypesofeconometricmodelsareemployed:thesingleequation
modelandthesimultaneousequationmodel

Single Equation Model

The single equation model assumes that one variable, the dependent
variable (also referred to as the explained variable), is influenced by
oneormoreindependentvariables(alsoreferredtoastheexplanatory
variables).Inotherwords,one-waycausalityispostulated.Anexample
ofthesingleequationmodelisgivenbelow:

Dt=a0+a1Pt+a2Nt

(4.11)

whereDt=demandforacertainproductinyeart
Pt=pricefortheproductinyeart
Nt=incomeinyeart

Simultaneous Equation Model

The simultaneous equation model portrays economic relationships in
terms of two or more equations. Consider a highly simplified threeequationeconometricmodelofIndianeconomy.
GNPt=Gt+It+Ct
It=a0+a1GNPt
Ct=b0+b1GNP1

(4.12)
(4.13)
(4.14)

whereGNPt=grossnationalproductforyeart
Gt=governmentalpurchasesforyeart
It=grossinvestmentforyeart
Ct=consumptionforyeart

Improving Forecasts
Youcanimproveforecastsbyfollowingsomesimpleguidelines:

Checkassumptions
Stressfundamentals
Bewareofhistory
Watchoutforeuphoria
Dontbedazzledbytechnology
Stayflexible

Uncertainties in Demand Forecasting

Demandforecastsaresubjecttoerroranduncertaintywhicharisefrom
threeprincipalsources:
Dataaboutpastandpresentmarket
Methodsofforecasting
Environmentalchange

Coping with Uncertainties

Given the uncertainties in demand forecasting, adequate efforts, along the
followinglines,maybemadetocopewithuncertainties.

Conductanalysiswithdatabasedonuniformandstandarddefinitions.

Inidentifyingtrends,coefficients,andrelationships,ignoretheabnormalorout-of-
the-ordinaryobservations.

Criticallyevaluatetheassumptionsoftheforecastingmethodsandchooseamethod
whichisappropriatetothesituation.

Adjust the projections derived from quantitative analysis in the light of

unquantifiable,butsignificant,influences.

Monitortheenvironmentimaginativelytoidentifyimportantchanges.

Considerlikelyalternativescenariosandtheirimpactonmarketandcompetition.

Conduct sensitivity analysis to assess the impact on the size of demand for
unfavourable and favourable variations of the determining factors from their most
likelylevels.

Market Planning
Amarketingplanusuallyhasthefollowingcomponents:
Currentmarketingsituation
Opportunityandissueanalysis
Objectives
Marketingstrategy
Actionprogramme

SUMMARY

Giventheimportanceofmarketanddemandanalysis,itshouldbecarriedoutinan
orderlyandsystematicmanner.Thekeystepsinsuchanalysisare(i)situational
analysis and specification of objectives, (ii) collection of secondary information,
(iii) conduct of market survey, (iv) characterisation of the market, (v) demand
forecastingand(vi)marketplanning.

The project analyst may do an informal situational analysis which in turn may
providethebasisforaformalstudy.

Forpurposesofmarketstudy,informationmaybeobtainedfromsecondaryand/or
primarysources.

Secondaryinformationisinformationthathasbeengatheredinsomeothercontext
andisalreadyavailable.Whilesecondaryinformationisavailableeconomically,its
reliability, accuracy, and relevance for the purpose under consideration must be
carefullyexamined.

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,thatislikelytobeasamplesurvey.

Typically, a sample survey consists of the following steps: (i) Define the target
population (ii) Select the sampling schemes and sample size. (iii) Develop the
questionnaire.(iv)Scrutinisetheinformationgathered.(vii)Analyseandinterpret
theinformation.

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:effectivedemandinthepastandpresent;breakdownofdemand;price;
methodsofdistributionandsalespromotion;consumers;supplyandcompetition;
andgovernmentpolicy.

Aftergatheringinformationaboutvariousaspectsofthemarketanddemandfrom
primaryandsecondarysources,anattemptmaybemadetoestimatefuturedemand.

Awiderangeofforecastingmethodsisavailabletothemarketanalyst.Thesemay
be divided into three broad categories, viz., qualitative methods, time series
projectionmethods,andcausalmethods.

Qualitative methods rely essentially on the judgment of experts to translate

qualitative information into quantitative estimates. The important qualitative
methodsare:JuryofexecutivemethodandDelphimethod.

Causalmethodsseektodevelopforecastsonthebasisofcause-effectrelationships
specified in an explicit, quantitative manner. The important causal methods are:
chainratiomethod,consumptionlevelmethod,endusemethod,leadingindicator
method,andeconometricmethod.

To enable the product to reach a desired level of market penetration, a suitable

marketingplan,coveringpricing,distribution,promotion,andservice,needstobe
developed.