Sales Forecasting vs Demand Forecasting: Breaking the Sales-Forecasting Vicious Circle

When it comes to business, predicting the future can be a tough challenge. One of the key areas of prediction is understanding how much of a product will be needed in the future — this is where demand forecasting and sales forecasting come into play. Though the terms are sometimes used interchangeably, they have distinct differences and purposes. Let’s dive in!

What is Demand, Sales & Supply?

Before we understand about forecasting, we should first understand some confusing terms

1. Demand: Demand is formally defined as what your customers want, when they want and how much they want. Its basically unconstrained. Your customers might want the products even if you have it in stock or not.
2. Supply: Supply is the inventory stock.
3. Sales: Sales happen when their is a demand and supply. It is constrained by both demand & supply, (complete/partial) absence of either one would have a pulling effect and result in (zero/low) sales.

What is Demand Forecasting & Sales Forecasting?

At first glance, sales forecasting and demand forecasting might seem like two sides of the same coin. And in some ways, they are. But there are fundamental differences:

1. Sales Forecasting: This predicts the amount of a product or service your business expects to sell over a specific period. It’s based on historical sales data, market trends, and external factors like economic indicators.
2. Demand Forecasting: This focuses on the estimated demand for a product or service. It considers factors like marketing campaigns, seasonality, and broader industry trends to gauge the consumer appetite for what you’re selling.

Sales forecasting is about what you think you can sell based on past data, while Demand forecasting is about understanding what the market might want in the future.

The Vicious Circle of Sales Forecasting

Sales forecasting plays a crucial role in determining the success of a business. However, if approached incorrectly, it can lead to a self-reinforcing cycle known as a vicious circle. This is particularly true when sales forecasts are based on constrained supply instead of genuine market demand.

Let’s delve into a straightforward scenario to understand this vicious circle.

Imagine you own an ice cream parlor, and currently, you’re running short on chocolate ice cream.

1. Sales Forecast for Chocolate Ice Cream: Given that you’re out of stock, you’d predict that your sales for chocolate ice cream tomorrow would be zero.
2. Demand Forecast for Chocolate Ice Cream: Even though you’re out of stock, there will probably still be customers walking into your parlor, hoping to enjoy their favorite chocolate treat.

Now, here’s where the vicious circle begins:

• If your purchasing manager, relying solely on the sales forecast, decides not to restock the chocolate ice cream (because recent sales were zero), you would indeed end up selling none the next day.
• This results in a misleading confirmation of your sales forecast’s accuracy. You predicted a sale of zero, and you indeed sold zero, achieving a 100% forecast accuracy. It might seem like a job well done on the forecasting front, but in reality, you’re missing out on potential sales and upsetting chocolate-loving customers.
• The circle perpetuates itself. With continued zero sales forecasts and subsequent decisions to not restock, you’re trapped in a loop where you never meet the actual demand for chocolate ice cream, even if the market appetite for it is robust.

How Do These Loops Happen?

It often boils down to relying too heavily on past sales data and not considering the broader market dynamics. While historical data is a valuable tool, it shouldn’t be the only factor in your forecasting. External factors, such as market trends, consumer preferences, and even global events, can impact demand and sales.

When to opt for Sales Forecasting

Given the pitfalls, you might wonder when it’s a good idea to use sales forecasting. Here are a few scenarios:

1. Consistent Historical Data: If your product has shown consistent sales over a considerable period, and no major market changes are anticipated, sales forecasting can be quite accurate.
2. Resource Allocation: Sales forecasting can help in allocating resources, such as staff during peak sales periods.
3. Cash Flow Management: Predicting sales can assist in managing cash flows, especially in businesses with seasonal variances.

However, always remember to blend your sales forecast with demand forecasting. Understanding potential demand while considering historical sales gives a fuller, more accurate picture, helping to avoid the pitfalls of the over-forecasting and zero forecasting loops.

Wrapping Up

Forecasting isn’t just about gazing into a crystal ball and hoping for the best. It’s a blend of art and science. By understanding the differences between sales and demand forecasting and being wary of the potential vicious circles, businesses can position themselves for success in both the short and long term. Always remember, a well-informed forecast is a tool, but it’s essential to remain adaptable and vigilant to market changes.