Four Steps to Forecast Total Market Demand

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Four Steps to Forecast Total Market Demand

F. William Barnett

Harvard Business Review
No. 88401


Four Steps to Forecast Total Market Demand
F. William Barnett

Recent history is filled with stories of companies and sometimes even entire industries that have made grave strategic errors because of inaccurate industrywide demand forecasts. For example: ▫ In 1974, U.S. electric utilities made plans to double generating capacity by the mid-1980s based on forecasts of a 7% annual growth in demand. Such forecasts are crucial since companies must begin building new generating plants five to ten years before they are to come on line. But during the 1975–1985 period, load actually grew at only a 2% rate. Despite the postponement or cancellation of many projects, the excess generating capacity has hurt the industry financial situation and led to higher customer rates. ▫ The petroleum industry invested $500 billion worldwide in 1980 and 1981 because it expected oil prices to rise 50% by 1985. The estimate was based on forecasts that the market would grow from 52 million barrels of oil a day in 1979 to 60 million barrels in 1985. Instead, demand had fallen to 46 million barrels by 1985. Prices collapsed, creating huge losses in drilling, production, refining, and shipping investments. Bill Barnett is a principal in the Atlanta office of McKinsey & Company. He is a leader of the firm’s Microeconomics Center, and his client work has focused on business unit and corporate strategy.

▫ In 1983 and 1984, 67 new types of business personal computers were introduced to the U.S. market, and most companies were expecting explosive growth. One industry forecasting service projected an installed base of 27 million units by 1988; another predicted 28 million units by 1987. In fact, only 15 million units had been shipped by 1986. By then, many manufacturers had abandoned the PC market or gone out of business altogether. The inaccurate suppositions did not stem from a lack of forecasting techniques; regression analysis, historical trend smoothing, and others were available to all the players. Instead, they shared a mistaken fundamental assumption: that relationships driving demand in the past would continue unaltered. The companies didn’t foresee changes in end-user behavior or understand their market’s saturation point. None realized that history can be an unreliable guide as domestic economies become more international, new technologies emerge, and industries evolve. As a result of changes like these, many managers have come to distrust traditional techniques. Some even throw up their hands and assume that business planning must proceed without good demand forecasts. I disagree. It is possible to develop valuable insights into future market conditions and demand levels based on a deep understanding of the forces behind total-market demand. These insights can


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sometimes make the difference between a winning strategy and one that flounders. A forecast of total-market demand won’t guarantee a successful strategy. But without it, decisions on investment, marketing support, and other resource allocations will be based on hidden, unconscious assumptions about industrywide requirements, and they’ll often be wrong. By gauging total-market demand explicitly, you have a better chance of controlling your company’s destiny. Merely going through the process has merit for a management team. Instead of just coming out with pat answers, numbers, and targets, the team is forced to rethink the competitive environment. Total-market forecasting is only the first stage in creating a strategy. When you’ve finished your forecast, you’re not done with the planning process by any means. There are four steps in any total-market forecast: 1. Define the market. 2. Divide total industry demand into its main components. 3. Forecast the drivers of...
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