TABLE OF CONTENTS

The Simulation: an Introduction | Vision and Corporate Design | Decision Variables | The Contracts Program
The Market Reports | Firm Reports: Credit, Sales & Production | Firm Reports: Financial Statements
The Scent Industry | Plant and Location  | Subsidiaries | Bankruptcy | Forecasting Demand | NPV | Broker

Forecasting demand is essential in order to plan raw material needs, set up production schedules, avoid special loans, and so forth. Accurate forecasting allows for the resources of the firm to be secured in advance at minimum cost. This chapter will help you develop a good forecasting model. Accurate forecasting is difficult to achieve, especially when you consider that each market group will develop a unique set of characteristics. This chapter will also explain the effects of contract sales and seasonal demand on forecasting as well as product loyalty.
 

Almost all spreadsheet models start with a forecasted demand or estimated sales. Many teams develop a system that provides consistently accurate forecasts. The first step in developing a forecast model is to understand how demand is determined in the simulation.

The market demand functions are changed each session. This requires that each new group of participants must determine the variables that most influence demand and how best to forecast demand. Don't rely on specific advice from previous players. Don't assume the price elasticities, demand functions or seasonal patterns fit real life examples.

Market potential is set such that an average market group price will create a demand for "X" number of finished good units. The potential is quite large at the beginning, allowing all the new firms easy access to the markets. Most firms find it relatively simple to initially make sales. As firms build new plants, expand capacities and start second shifts, supply soon equals the preset market potential. Under normal circumstances, the industry "matures" early in the second year. After that, growth continues along the lines preset by the administrators.

It is important in the early quarters, that forecasters do not assume rapidly increasing sales are a function of a strong growth element in the industry. Most of the sharp increases in sales are due to supply growing, not new demand.

Within this simulation model, market potential is not a set number installed by administrators, it is a base number. The base number is affected, as consumers would be, by a host of market group inputs. The administrators use exactly the same base numbers and defined consumer characteristics in each of the identical market groups. However, as the individual firms make decisions, their combined numbers affect the market potential.

Thus, two market groups, exactly the same, but with two very different average market group prices, would have two very different levels of demand. This difference in the total number of units demanded is due to the participant's decisions, not the administrator's design.

Not only does price elasticity play a major role in deciding which firm gets the sale, it determines, using the average market group price, how many sales there will be across the entire market group. The market group demand is also influenced by the number of sales representatives promoting the product and their motivation. The market group standard of quality is a factor, as is the number of firms conducting business in the market group. Another major influence is the total amount of advertising dollars being spent currently and in recent quarters.

Other macroeconomic forces are at work on the market potential. Key among these is the bill rate which, in part, is the measure of the money supply and economic activity. The Bear/Bull market also has a modest impact on the market potential.

If it sounds complex, it is. But not so complex that forecasting should be abandoned. You will find sufficient information in the Market Research Reports to allow you a reasonable start at forecasting. Keep good records and analyze the general trend of the market group as well as your firm. We recommend you monitor other market groups that start in an identical position as yours. Those market groups might provide some insight into pricing policy or advertising practices and their effect on market growth.

It often happens that identical market groups develop very different production and marketing structures. All firms might be very successful in one market group but only moderately successful in another. For example, in a recent simulation, one market group had five out of five firms attempting to niche the market. Even after year two, they all continued on with the same strategy. The average market group price was high, the firms small with few sales reps and little advertising (but high average quality). In year three they raised the average price so high, each trying to be the high price leader, that for Product 2, there were no sales. Consumers went to high quality world famous brands outside the scope of the simulation, opted not to buy anything, or went to cheaper imports.

In another market group which started exactly the same, business was booming. This group had large firms with high volume firms in the middle price range and a couple of market nichers. Given the large number of sales reps, large advertising budgets and lower average market group price, everyone was profitable. The market group had matured and stabilized.

The Scent Industry Section will provide you with specific data related to the quarterly seasonal pattern for each product. Seasonal fluctuations are very sharp. They remain stable over long periods of time. In this simulation an average quarter is defined as "1" or 100%. Each quarter has its own seasonal value.

For example:
Q1 = .8
Q2 = 1.2
Q3 = 1.6
Q4 = .4

It is essential that seasonal adjustments be made in order to achieve accurate forecasts.

Accurate forecasting is a difficult task. When you forecast you are examining a range of possible outcomes, rather than a single finite number. The future is uncertain. How do you feel about market growth, the competition, and other uncontrollable factors? Would you consider your firm conservative or aggressive?

The following model can be used to forecast unit demand for your firm. Be aware, however, as you work with the model that it is just that, a model. No one can provide an exact calculation for predicting the future. Learn your environment, the markets, the competition, your own team's capabilities; and your forecasting will grow more precise.

To show you the possible range in forecasting, the formula is applied to a conservative and an aggressive estimate (actual would probably fall in the middle of these two extremes).

Forecasting Model:

1. Determine overall market demand.
2. Determine your real market share
3. Multiply real market share times forecasted market demand

In order to begin, you must calculate from your own firm's numbers and those given on the Industry Report, demand for the entire market group. Once you have an accurate picture of overall demand, you can then work backwards to determine what share of that potential market you actually captured.

Following are the variables which you must use to calculate overall demand within your market group.
 

Note that the only difference between the conservative forecast and the aggressive forecast is the treatment of backorders. The aggressive forecaster assumes that all firms had similar backorders this quarter, and that no competing firms had backorders in the previous quarter.  The conservative forecaster seeks to make sure that demand in the coming quarter is fully met. The aggressive forecaster tries to hone the number more precisely.

Also note that the Ending Sales Lost figure and the Contract Sales figure are for the entire market group, not just for your individual firm.

Now, assume the firm in question had 5000 unit sales of Product 1 in Area 1 and 1000 backorders of Product 1 in Area 1 for Quarter 1. In Quarter 4 of the previous year they had 2000 backorders. Their market share for Product 1 in Area 1 was 10%. Ending Sales Lost for the market group was 500 P1A1. Contract sales within the market group for Product 1 in Area 1 was 4000 units. The seasonal ratio for Quarter 2 forecasting is 1.2/.8.

The firm must apply the variables as indicated in the table in order to determine total market group demand.

Step1
5000 sales - 2000 B.O. last qtr/ .10 = 30000 units

Step 2
30000 units + 500 Ending Sales Lost  - 4000 market group contract sales = 26500

Step 3
26500 units x (1.2 /.8 seasonal ratio) = 39750

Total  = 39750 forecasted market group demand Q2

Step1
5000 units + 1000 B.O. this qtr / .10 = 60000

Step 2
60000 units + 500 Ending Sales Lost  -4000 market group contract sales = 56500

Step 3
56500 units x (1.2/.8 seasonal ratio) = 84750

Total  = 84750 forecasted market group demand Q2
 

Now that you know what the potential market was for Quarter 1, you need to find your adjusted market share. Continue with the previous example.

First calculate the firm's adjusted units sold. To do this subtract contract sales for the firm and last quarter's backorders for the firm from the unit sales figure.

Next, divide the adjusted units sold by the market group demand figure calculated previously. Note: do not use the forecasted number, but the demand figure for the current quarter (before the seasonal ratio was applied).

Assume the firm in our example sold 1200 units of P1A1 through contracts.
 
 

Step 1.
5000 units - 1200 contract sales - 2000 B.O. last qtr = 1800 adjusted unit sales

Step 2.
1800/26500 = 6.79% adjusted mkt shr

Step 1.
Same as above = 1800 adjusted unit sales

Step 2.
1800/56500 = 3.18% adjusted mkt shr

Now you have an accurate figure for market group demand and an accurate number for market share. The last calculation is very simple. Multiply the forecasted market demand figure by the adjusted mkt share figure

39750 units x 6.79% =  2699  forecasted unit demand for Q2

84750 units x 3.18% = 2695 forecasted unit demand for Q2

It is important to use the same method to determine fluctuations in market share. While the number might not be exact, as long as you are consistent in your calculation process, changes in market share will be useful marketing information on which to base decisions.

If a firm cannot fill orders, this generates backorders and sales lost. The program makes two attempts to locate one of your competitors with finished goods available in that market area. If the program, which is simulating a professional buyer, fails to completely or partially cover sales lost, the order goes to importers. If you are that fortunate firm with finished goods left over after satisfying your clients, (even if you have a poor marketing package) you will have great sales and a good market share.

That is, until the firms spending all the money on marketing actually get the units they need out of production. If a firm successful in marketing but weak in production suddenly opens a second shift, contracts for goods, or builds a new plant, it can have a devastating impact on the market share of a firm living on another's lost sales. In some cases, market shares can decline by as much 50% to 75%, or more if the successful marketer initiates a new promotional package at the same time that extra production becomes available.

How can you tell if you are at risk in such a situation? It is very difficult to do so. However, there is one case where a firm can get a strong indication that the lost sales of competitors are part of their market share. If a firm has no backorders, no sales lost and no finished goods inventory, they either hit a one in a million chance of making exactly the amount that was demanded, or professional buyers wanted the other firm's products but had to settle for yours instead because the other firm stocked out. If this happens to your firm, there is some lurking danger to your market share.

Loyalty is something that is built up over time. You are a new firm in a new sector of the market. By the end of year two, some firms will have built some loyalty into their product lines. However, you are not selling to end consumers, but to professional buyers that have an eye on profit margins versus consumer demand. Don't count on product loyalty to defend your firm from an aggressive competitor. Loyalty will help delay the onslaught of a ruthless competitor, but eventually, rational professional buyers will add the competitor's lines.

A carefully implemented and very aggressive non-price marketing attack may be hidden from your view by the competing firm's inability to fill demand. When production finally meets their newly created demand, your market share(s) could drop like a rock. The competitor may have been waging war for three quarters and you were not aware of it. They may have built up a huge following based on advertising, quality product image and aggressive marketing reps. In this case, your market shares could slip from 35% say to 5% in one quarter.

They caught you napping! What can you do? The normal reaction is to cut price. That will help, but little market share will shift your way since the competitor now has loyal clients. Price is also a very easy item to spot. Be careful unless your firm has some cost advantage over the competitor. An attempt to match your competitor in non-price promotional activities could take three or four quarters. The program simulates professional buyers and end consumers with advertising and quality memories. An exact budget match on those variables will be an exact match only after three or four quarters. Consider matching per unit, not total budget unless both competitors are about the same size.

Your firm could attempt to saturate the market with advertising and quality imaging. That is, do in one quarter what your competitor did in three. This will take a lot of cash and cut profit margins. Maybe you can catch your competitor napping!

Remember that it is not the total amount of monies thrust into marketing that counts. It is understanding the variables and designing the right promotional mix. If your mix is wrong, it may take three or four times the total budget of the competitor just to stay even. For a dollar spent on marketing, what got you the most sales for a particular product in the past? Price, quality, reps on commission, base salary, no sales lost, credit policy, advertising, stability in pricing, quality and service? Is the mix different for P1 and P2?

In this regard, realize that consumer sales fluctuate with interest rates, average market group prices and other variables. The right marketing mix will not change dramatically over the course of the simulation, but it could exhibit some change over time due to changes in the economy.

Be aware that it is not just you and your competitor(s) slugging it out. Since you are selling through distribution channels, even a modest change in consumer buying can have a major impact on manufactures. This magnification of consumer buying behavior is due to inventory patterns of wholesalers, distributors and retailers. If they all decide to cut inventories because they think consumer spending will be down, demand can nose dive at the manufacturing level.

Firms engaged in forecasting must keep current as to changes and moods in the economy through reading the quarterly news. In past simulations (not all of them), news reports predicted changes in the way consumers reacted to a product. Mounting public opinion that a particular product was unsafe just about shut one market down. A forecast model should be used for forecasting, but the results tempered by common sense. If your forecaster does not have common sense, then stick to the model's forecast but carry a sizeable financial cushion!