What Is Demand Estimation?

Good business decisions are almost always based on fact. Factual data provides a measure of objectivity, even when a decision ultimately comes down to your best educated guess. Although demand estimation is really an educated guess, it can include the use of fact, up to and including a set of complex statistical calculations that can be difficult to understand and to complete. While other available methods may be less scientific, they are also easier to use. Because demand estimation provides crucial information, every business owner should be familiar with the concept and know how to apply estimation results.

Demand estimation is a prediction focusing on future consumer behavior. It predicts demand for a business’s products or services by applying a set of variables that show how, for example, price changes, a competitor's pricing strategy or changes in consumer income levels will affect product demand. Once armed with this information, management can then begin to make strategic business decisions ranging from reviewing pricing strategies to setting product inventory levels to deciding whether to make fixed asset investments and whether to introduce a new product or enter a new market.

Consumer interviews, surveys and focus group meetings are a grass-roots method of estimating demand. The method operates under the idea that consumers know themselves best and that interacting with consumers directly is the best way to estimate future product demand. Getting information directly from consumers, however, decreases objectivity and increases the chance of errors. It can be difficult, for example, to get a truly random sample of the target consumer population. Consumer responses may also be biased in that responses may not reflect what a consumer will do, but rather what they would like to do, or a consumer may be unable to provide a precise or accurate response.

Market studies are a direct demand estimation method that combines consumer interaction with science. The process starts by setting a constant, such as price, and variables such as size and/or color. Market studies then display products at, for example, the same price, but in a variety of sizes and locations or settings over a period of time. Once the study is complete, analyzing the results reveals how demand for the product at that price changes according to, in this case, size or color.

Demand estimation can also rely on regression analysis, a statistical way to find the best relationship between a dependent variable – in this case, product demand – and one or more independent variables, such as price or location. Although fully understanding demand estimation calculations requires a background in statistics, the process is not difficult to understand. Setup starts by identifying and obtaining data, such as cross-sectional market data or results of a time study or consumer survey on the independent variable or variables to be used in the calculation. Next comes choosing between using a simple or multiple regression model, depending on whether the calculation includes one or multiple variables. Both models display demand as an unknown. Parameters such as a specific price or average annual income are set. Statistical calculations can then begin, and management can move on to interpreting results.