How you can leverage demand analysis to improve your forecasting models
A demand analysis is a process that allows businesses to better understand the demand for a product or service they offer in a particular market. Running a demand analysis is an impactful process for any business, revealing new efficiencies and opportunities to pursue. It involves researching the needs of a subset of potential customers, as well as how much they’re willing to pay for a product to address these needs.
What you need to know about a demand analysis
Demand analyses are a great tool to help you understand and prepare for variations in demand over time. While you’re probably aware of common and impactful factors affecting demand analyses such as seasonality and accessibility, it’s important to explore new information sources to improve your demand forecasts. In a globalized economy, changes in preferences, populations and economic circumstances are common and will throw off your forecasts if you’re not keeping tabs on demand causal factors.
Having an inaccurate forecast will cause a number of problems for your business. Without having correct insights into future demand, you will experience:
Unexpected spikes and dips in sales
Costly inventory discrepancies
Over- or under-scheduled shifts
Optimizing for the features driving real-world demand allows you to gain insights into where to invest capital and resources. Using a demand analysis will help you reduce error rates in your forecasting, and generate more accurate demand predictions.
The Law of Demand
In order to better understand how demand patterns influence your business, you’ll need to recognize a few rules about demand and how it works.
The Law of Demand describes consumers behavior as it relates to fluctuations in price. The higher the price, the lower the demand, and vice versa. There are a couple of key concepts to understand:
The Law of Diminishing Marginal Utility states that as you obtain a higher quantity of a product, you experience less and less benefits from any additional units of this product. If you ran a coffee shop, a customer would buy one coffee drink, maybe two, but likely not more than that. Because of this, an accurate demand forecast is key to ensure that you’re not over or under-spending on inventory and labor.
The Income Effect dictates that lowering the price of goods or services makes it more financially accessible to a larger portion of consumers. In the coffee shop example, this means that the higher income your customers have, the more willing they would be to buy coffee, more expensive drinks, and more complementary goods like coffee beans or snacks.
The Substitution Effect tells us that when products that could be substitutes for yours are priced higher, a consumer will buy more of your product at the lower price.
All of these circumstances need to be considered in tandem when a business is trying to determine how much demand there will be in a given market for your products and services.
Types of demand
There are several categories of demand. Identifying each allows you to get more granular about the factors that influence it.
Direct Demand: demand for your products that are universally needed. In the example of running a coffee shop, this would be demand for drinks.
Indirect Demand: demand for consumer goods for production, like raw materials, capital, or machinery to build products. In this case, there could be demand for the physical real estate of the shop in a location that experiences a lot of foot traffic.
Joint Demand: demand factors that work in tandem to satisfy a particular need. For example, an early-morning conference around the corner from your coffee shop can trigger an influx of customers before the usual morning rush.
Composite Demand: demand for something that solves several needs at once. An example would be the demand for water, which could be for drinking, making coffee, or washing dishes.
How to conduct a demand analysis
Given the increase in volatility, many companies are looking for new ways to better prepare for future instances of both incremental and decremental demand.
The four steps to perform a demand analysis:
Kick off market identification: Identify the target market for your product and services, usually with the help of surveys and feedback from potential customers.
Assess the business cycle: Assess the current stage to understand if it’s emerging, plateauing, or declining. An emerging market is going to have the highest demand for a product, while a declining market is one that’s already saturated with a particular service. The plateau is the sweet spot of equal supply to meet the demand by the given market.
Fine tune your offering: Product niche involves tailoring the product or service details to meet the needs of a particular portion of the market. Understanding when and why people purchase is also key, and requires you to track these demand causal factors. Having the right product niche for the specific populations you’re targeting will help stimulate demand for your business and differentiate you from your competitors.
Evaluate competition: It’s important to assess potential competitors and their market share, as this will give you a good understanding of the business cycle of that market. Having fewer competitors will enable you to capture a higher portion of the market share, and therefore create more potential for profit for your business.
Elite demand analysts and forecasters also consider external demand causal factors. Demand doesn’t exist in a vacuum: real-world events need to be taken into account. For example, an unscheduled event like severe weather can influence supply and demand for things like umbrellas and raincoats. Alternatively, scheduled events like conferences and expos can drive up demand for accommodations at hotels. Different businesses need to keep tabs on how demand can fluctuate based on what’s going on in the world around them, and plan accordingly.
Enhanced demand analyses improve forecasting accuracy
Here’s how businesses can enhance their demand analyses:
Add external information sources to your demand forecasting efforts. By looking at external factors like weather, holidays, festivals, and more, you’ll be able to better predict future demand trends.
Correlate impactful events against your own sales data can offer unique insights into which specific events really impact demand for your particular business.
Define the impact of different demand causal factors. Not every demand signal is going to be as important for your demand analysis and forecasting efforts. Get insights into the impact that different factors might have to make sure you’re attributing an appropriate level of incremental or decremental demand to each factor.
Your demand forecasts can only be as good as your information sources. To create a more accurate demand analysis, you need to leverage external data sources. If you want to learn more about how event data can help your business understand your target market better, contact us here.