CHAPTER 4

FEASIBILITY STUDY: DIMENSIONS AND REPORTING

4.1. The Pre-Investment Phase

According to the UNIDO, the pre-investment phase in the project cycle involves the following major activities
and/or stages:
 Opportunity Study,
 Preliminary Project Identification,
 Preparation (that involves Pre-Feasibility and Feasibility Studies), and
 Appraisal and Selection.
The stage of project preparation, among others, is one of the most important, critical, costly, as well as complex part
of the project cycle, which is, literally, involving both pre-feasibility and feasibility studies. In this regard, the two
studies made in the preparation process are having the same structural framework; except that they differ in the
scope or level of detail included in the assessment.
In general, the major dimensions/components of the study, and that of preparation, are the following:
 Commercial Dimension: Market and Demand Analysis
 Technical Dimension:
Developing Production Program and Determination of Plant Capacity,
Input (Raw Materials & Supplies) Studies,
Location & Site Studies and Environmental Impact Assessment, and
Engineering & Technology Study.
 Institutional & Managerial Dimension
 Financial Cost-Benefit Analysis
 Social Cost-Benefit Analysis (often called Economic Analysis).
Due to their significance and potential implications of the outcomes, project planners should strategically consider
diverse factors in this Pre-investment phase and would better have strategic orientations especially in the
preparation process. The Analyst in the pre-investment phase, therefore, has to have the following strategic
orientations:
Search for the Right Investment:
ƒ An investment that can economically achieve its objectives over its life.
Cope Up with the Dynamism/Change in the Environment:
ƒ Take in to consideration environmental changes and effects of dynamism.
Seek Competitive Advantage:
ƒ Identify projects creating competitive advantage to the firm and astutely develop competitive strategies
responsive to changes.
Develop Functional Objectives:
ƒ The functional objectives should be made to be challenging; yet realistic.
ƒ Functional objectives should be developed in the areas of Marketing, Production, Supplies, R&D, Finance,
Personnel, Organization and Management.

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 4.2. Project Preparation
4.2.1. Major Aspects
When project analysis has failed to anticipate the outcome of a project investment, a common reason appears to
have been simply poor preparation of the analysis in the pre-investment phase. Practices have shown that, as a bitter
consequence of poor project preparation, too many industrial projects suffer in terms of
 Low capacity utilization,
 Heavy costs overruns,
 Deteriorated financial profitability,
 Lingering illness or the sudden death syndrome, and etc
These are primarily resulting from flaws of the analysis in the stage of project preparation. Some of the common
mistakes during preparation are the following:
ƒ Overestimating returns:
Overestimating returns from investment during preparation because sometimes the analysis fails to
account adverse effects over the investment during later plant operations (production period), either
in the project area or elsewhere (for instance, for irrigation projects).
ƒ Underestimating costs:
Underestimating costs are common, either because of the analysts being systematically optimistic about
costs or making especially poor estimate about the cost of a particular component.
ƒ Omission of a necessary component (often resulting from less precisely defining the project’s scope):
Sometimes a component necessary for proper functioning of the project or an activity critical to the
project is omitted from the cost estimates.
ƒ Optimistic projections (such as periodic yields, rate of increase/decrease, etc)
Excessively optimistic projections often made during project preparation (for instance, areas to be
brought under cultivation, yields to be obtained, rates of increase in livestock population in a given
area, etc in agricultural projects).
ƒ Failure to consider the variability of climate (environmental changes)
In agricultural projects, often there is a failure to consider explicitly the variability of the climate and,
thus, overestimate returns.
ƒ Optimistic calendar for implementation
Too optimistic a calendar for project implementation- the analysis often does not test the effect of
delay in getting the project underway over the project’s return.
Because of the aforementioned flaws in project preparation, survival aids granted to sick industries pose heavy
budgetary burdens in the form of subsidies.
ƒ From the macro-economic point of view, this implies the prevalence of misallocations in (or poor
allocation of) resources and ultimately severe losses of scarce resources.
ƒ Thus, in order to design and analyze effective projects, those responsible must consider many aspects that
together determine how remunerative a proposed investment will be, since the activities are interrelated
and have both forward and backward linkages.
ƒ Each of the aspects touches on the rest and a judgment about one aspect affects judgments about all others.
Therefore, the analyst must consider and reconsider all the aspects at each stage in the project planning
and implementation cycle.
 4.2.2. Pre-Feasibility Study
A pre-feasibility study is a general, not a detailed, assessment (or examination) of the basic components of the
industrial project. A detailed review of available alternatives and screening out projects that are not eligible for
further assessment, however, must take place at the stage of the pre-feasibility study, since it would be too costly,
time consuming, as well as not justifiable to have this done at the feasibility study stage.
Objectives of Pre-Feasibility Study:
The basic objectives of pre-feasibility studies is to
 Examine possible project alternatives;
 Determine whether the project concept justifies further study and a more detailed analysis; and
 Determine whether the project idea is promising or non-viable at initial screening.
4.2.3. Feasibility Study
A. Objectives:
o To define, in a more tangible form, the viability, quality, and dependability of project ideas based on
detailed and thorough analysis of the issue.
o To provide a basis for the final investment decision.
B. Considerations:
A major responsibility of the project analyst is to keep questioning all the technical specialists, who are contributing
to a project plan, to ensure that all relevant aspects have been explicitly considered and allowed for. In this regard,
feasibility studies:
ƒ Require involvement of professionals in an interdisciplinary team process.
Project planning is an interdisciplinary, interactive, and team based activity.
ƒ Should arrive at definitive conclusions regarding the basic aspects of a project after considering various
alternatives.
ƒ Should define all project features as precisely as possible.
Define the scope of the project unequivocally so that not to omit important aspects and associated
costs.
There is no uniform approach for all projects. The level of detail and emphasis on the various aspects
varies from project to project. [For example, big Vs small projects; industrial Vs rehabilitation
projects, etc].
Carefully estimate and/or evaluate sensitive parameters like: sales (size of market & quantity sales);
production program and plant capacity; and selection of technology, machinery, and equipment.
Make sure that funds will be obtained up on favorable out comes before conducting the study.
ƒ The out comes should be detailed enough to provide the basis for and/or enable the process of making
subsequent decisions, for instance, financing/sponsoring decisions by the concerned.
ƒ The description of the project components should be well refined in order to permit executing agencies to
use the study as a guide for project implementation.
ƒ Project planning is an interdisciplinary activity involving engineers, economists, financial analysts, and
specialists in areas such as agronomy, environmental health, soil science, geology, hydrology,
manufacturing, processing, extension, and management. It is frequently becoming more important to consult
sociologists too.
However, it is worth mentioning that feasibility studies are not always free from vested interests. Those who
commission studies, for example: governmental institutions, investment promotion organizations, development
banks, as well as private companies, are facing the problem of receiving/obtaining objective, justifiable, and neutral
expertise advice and feasibility reports. These institutions also lack integrity some times in their practices.
Those supplying and offering feasibility studies, such as Consulting Firms, Industrial Enterprises, Turnkey
Contractors, and Equipment Suppliers, rather have more strong self-interest sometimes. That is why there are so
many “White Elephant” projects, completely unprofitable and wasting away scarce resources.
Therefore, one should have a sharp eye on the crucial aspects of a feasibility study as well as on the participants
thereto. Moreover, it is not only necessary to have a professional interdisciplinary team work, but it is also
indispensable to link all planning activities as early as possible at the pre-feasibility study, and even at the
identification stage, with all parties involving in the project preparation.
4.3. Reporting Format
4.3.1. Executive Summary
The executive summary is a summary of the findings in the feasibility study. It outlines the project background,
critical data & information, major outcomes, and relevant conclusions & recommendations given by the team of
professionals, who had participated in the feasibility study.
1. Structure:
The Executive Summary is prepared in line with the structure of the body of the feasibility study.
2. Content:
The Executive Summary presents summary of the contents of the feasibility study pertaining to the following
aspects:
 Project Background & History;
 Market and Demand Analysis;
 Raw materials & Supplies Aspects;
 Location, Site, and Environmental Impacts;
 Engineering and Technology Aspects;
 Organization and Management Issues;
 Human Resource Requirements;
 Financial Analysis and Appraisal (Total Investment Cost, COGS, Operating Costs, Financial Costs);
 Economic Impacts/Social Cost-Benefit Analysis and Appraisal;
 Project Financing; and
 Project Implementation Schedule.
4.3.2. Project Background and Basic Idea
Deliberates how well the project fits in to the overall development framework and objectives.
Description of the Project Idea:
 Project Objectives (UNIDO, A Guide to Practical Project Appraisal, 1978, page 59 - 60);
 Project Location and Site;
 Product and Product Mix;
  Plant Capacity & Implementation;
 Project Consistency with Development Priorities;
 Policies Supporting the Project (Economic, Industrial, Sectoral, Social, etc);
 Geographic Spread of Sale of Products; and
 Project Coverage (Sectoral & Sub-Sectoral).
Project Promoter/Initiators:
 Who are the promoters?
 What is the role of the promoters in the project?
Project History:
 Historical Developments of the project (major milestones).
 Opportunities Conducted (opportunity & feasibility Studies).
 Conclusions of the feasibility study (summary of the findings and conclusions in the study).
Feasibility Study:
 Who undertook the feasibility study?
 Who sponsored the feasibility study?
Costs of the Studies:
ƒ Costs of the opportunity and feasibility studies.
 PART II:
PROJECT PREPARATION

Section A: Commercial Dimension

Section B: Technical Dimension

Section C: Institutional Dimension

Section D: Financial Cost-Benefit Dimension

Section E: Social Cost-Benefit Dimension

 SECTION A: COMMERCIAL DIMENSION
CHAPTER 5
MARKET AND DEMAND ANALYSIS IN PROJECT PREPARATION

5.1. Overview of Market and Demand Analysis

5.1.1. Objectives of the Study
The study of market and demand analysis, being the first step in project preparation, has the following main
objectives:
 To systematically assess the market and the market environment to generate pertinent data;
 To collect, analyze, and report data about a specific market situation;
 To obtain insights about the target market structure;
 To identify customers, their needs, and behaviors in the market;
 To design the marketing mix that fit in the context;
 To identify available distribution channels;
 To identify competitors and their characteristics in the target market;
 To determine the socio-economic aspects relevant to the preparation and evaluation of the project’s market
strategy;
 To identify the existing strengths and weaknesses in the internal environment of the firm;
 To project the level of demand expected;
 To delineate marketing opportunities and risks;
 To decide on subsequent aspects of a project; and
 To develop sales program of the firm.
5.1.2. Rationales for conducting it First
Engineers, Financial Analysts, as well as Economists, who have to calculate the socio-economic costs and benefits of
a project, can only start their job if the market analyst has finished his/her part and has delivered a sales forecast and
market strategy to his colleagues. In other words, every part of the project preparation process and/or all the other
dimensions of the feasibility study depend on the information provided by the market and demand analyst, [i.e. on the
sales forecast and marketing strategy selected].
They all depend on this information, which has strong implications, for instance, on:
 Production program and capacity planning,
 Input and location selection,
 Technology selection,
 Staffing the sales unit (marketing section),
 Promotion and service department,
 Working capital needs, and
 Financial planning.

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They also rely on the quality of the market analysis, since their calculations can easily turn out to be waste of time if
the demand and sales forecast has to be revised. Moreover, market analysis is obviously more ambitious and risky
in comparison to the other parts of a feasibility study, as it has to fight with the future. The projection of future
demand and the level of expected sales require by far deeper “Look in to the Crystal Ball”. Market research needs
imagination, creativity, and feeling.
 It requires sound and intuitive judgment in addition to relaying on quantitative grounds.
 It has to fight with the future, i.e. with great uncertainties in the market.
 It deals with the fundamental source of income, revenues, with which stream of returns would be obtained to
compensate the promoters and attain objectives.
The marketing aspect and the demand and sales forecast are necessarily subjective and vague, since, in the
final end, the analyst has to:
 Deal with the behavior of human beings;
 Assume how customers respond to the taste, smell, and to all the properties of the product, i.e. to the design,
packaging, labeling, and, not to forget, to the price.
The market research cannot provide forecasts in certainty, particularly, if we take into account a project’s total life
span of 10 – 15 years notwithstanding its broad based significance. However, the analyst can still forecast sales,
with a good approximation, based on the outcomes in the systematic assessment of the market and its environment,
referred to as the market research.
5.1.3. Implications for Project Analysis
In most cases, the first step in project analysis is to estimate the potential size of the market for the product
proposed to be manufactured (or service planned to be offered) and get an idea about the market share that is likely
to be captured. Put differently, market and demand analysis is concerned with determining the:
 Likely aggregate demand for the product, and
 Possible market share expected for the product.
The first stage in preparing the feasibility study comprises the estimation of size, composition, and development
trends of demand for the product or products, careful analysis of determining variables and their market
environment, demand forecast and the ultimate goal of the procedure: sales volume and revenue projections. The
extensive and careful analysis of past, present, and future demand for the product to be produced, together with market,
institutional, and political forces influencing demand and sales of the product in question, is of crucial importance to the
success of the entire project.
Estimates of sales revenue, at a later stage of feasibility study, will be the basis for evaluation of alternatives and
final decisions regarding:
 Production program,
 Plant capacity,
 Material and inputs choice,
 Location,
 Financial evaluation, and
 Ultimate marketing strategy.
In this regard, once the sales projections are available, a detailed production program should be prepared showing the
various production activities and their timing. The production program is primarily dependent on projected sales. In
addition to this, we need to determine the plant capacity taking into account alternative levels of production, investment
outlays, and sales revenue. It is also obvious that expected sales would form one of
the important determinants of plant capacity decision. The same is true for decisions on materials and inputs, being
the consequence of production program. Proximity to the main markets and existing transportation facilities, among
other considerations, will affect the choice of plant location, particularly for bulky and/or perishable products.
All measures of financial evaluation of project’s feasibility are based on estimates of costs and revenues. Thus, an
inaccurate or wrong demand and sales projection, being the result of careless and lighthearted attitude towards
demand and market analysis, may lead to ultimate project failure despite all the financial analysis showing the
project to be perfectly viable on paper. Market and Demand Analysis is, therefore, the first “screening” stage in the
feasibility study, at which projects that cannot expect satisfactory market acceptance shall be rejected. It is much
easier and cheaper to screen out a project at this stage than to have it rejected by the market.
The practice of feasibility study in project preparation is largely an iterative procedure and, therefore, involves a
number of back – and - forth steps. The final sales projection cannot be made without a decision on specific price
level and this, in turn, cannot be made prior to determination of production costs and break-even analysis, which
will be conducted at the later stage.
Given the importance of market and demand analysis, it should be carried out in an orderly and systematic manner,
which once again emphasizes on the necessity of a market research. In general, the key steps in market & demand
analysis (or market research) logically comprise the following:
 Situational analysis and specification of objectives,
 Collection of secondary information,
 Conducting market survey (primary information),
 Characterization of the market,
 Demand forecasting, and
 Market planning.
5.1.4. Market and Marketing Concepts
1. Market:
A Market is an institution set up by society as an important means to allocate scarce resources in the economy.
ƒ It is a locus of all potential customers involving in exchange of values to satisfy their needs.
ƒ It channels/transfers resources from one unit to another unit (entity) in a given context.
2. Market Participants:
The following entities are among the market participants:
 Producers of inputs/outputs: Input suppliers (raw materials and manufactured inputs) and Output suppliers
(finished goods and services for consumption or use);
 Sales agents, distributors (wholesalers and retailers), and commission brokers;
 Transportation agents (distribution channels);
 Competitors and partners;
 Consumers;
 Regulators and so on.
3. Marketing:
Marketing is the process by which solicit members in the society obtain what they need through creating and
exchanging goods and services with others for identifiable economic return. Nowadays, the definition of
marketing is broadened to include even the exchange of ideas between social and political entities, (for example,
election campaigns).
4. Marketing Mix:
The Marketing Mix (often referred to as the 4P’s) is mixture of controllable marketing variables that could be used
by a marketer to achieve the desired sales level (or marketing objectives) in the target market. These 4 P’s are
Product, Price, Promotion, and Place.
Product:
 Quality  Warranty
 Features
 Design  After sales service
 Packaging
 Brand
Price:
 List price (cost-plus approach, marginal cost approach)
 Discounts policy (cash, quantity, and trade discounts)
 Payment terms and delivery agreement (credit terms)
Promotional Mix:
 Advertising
 Public relation
 Personal selling
 Sales promotion
 Publicity
 Place:
 Distribution channels (wholesalers, retailers, direct sale to customers)
 Storage (or stocking): warehouses and standard requirements
 Transport (railways, vehicles, water, air, etc)
5. Marketing Strategy:
Marketing Strategy is a specific weapon, tool, or approach that the firm chooses to follow, which comprises the
basic variables in the marketing process. It is a broader plan that the company uses in order to achieve its marketing
objectives. It encompasses:
ƒ Marketing Expenditures: [Amount, Frequency, Significance to be obtained, Ability to provide Competitive
Advantage];
ƒ Marketing Mix: The degree of combination (proportion) of the controllable and measurable marketing variables in
order to give the firm unique competitive posture in the market; and
ƒ Competitive Strategy: [such as low cost leadership, high quality and differentiation, delivery performance (fast
delivery and reliability in delivery), and flexibility & customer service].

6. Elements of Marketing:
Elements of the Commercial Dimension in project preparation:
ƒ Market Research: The first & basic task in any market and demand analysis is to generate relevant information
useful for doing the subsequent tasks.
ƒ Marketing Plan and Budget: A plan of action and budget prepared on the basis of the results of the market
research.
5.2. Market Research
5.2.1. Scope of Market Research
A market research is a systematic assessment of dozen of issues in the market and the marketing environment,
which is an important means of getting necessary information regarding the characteristics, opportunities, threats,
needs, behaviors, and dynamics in the socio-economic environment. It involves the design, collection, analysis,
interpretation, and reporting of data about a specific market situation.
Scope of the market research covers the following aspects:
 Assessment of target market structure [market definition: product, region, target market, suppliers,
customers, competition, distribution channel, etc];
 Analysis of customers and market segmentation;
 Analysis of distribution channels;
 Analysis of competitors;
 Analysis of socio-economic environment;
 Internal (organizational) analysis; and
 Projection of market data (which is key output of the market research).
5.2.2. Aspects of Market Research
i. Assessment of Target Market Structure
The first step in the demand and market analysis is to define the market and assess the target market structure in
view of the following components:
Market Definition
ƒ Products: What type of Goods or services? (Specific type).
ƒ Region: Where to market (or sell) the products? (Broadly identify).
ƒ Target market: To which customers or customer groups to provide?
 Structure of Target Market
Suppliers Structure:
ƒ Suppliers of goods and services (Existing, Potential).
ƒ Organization of suppliers' product brands:
Single branding/multi-product branding [same brand for line of products].
Multiple branding – every item produced by a firm may be given different brand name.
Private branding – retailers might give and use their own-brand names while distribution.
Generic branding – that is, products branded based on one of its components (item used as a mixture).

Customers:
ƒ Who are customers?
ƒ Types of customers.
Industrial/Business buyers;
Government units; and
Consumers.
ƒ Size of the customers (large versus small buyers).
Competition and Competitors:
ƒ Capacity utilization of competitors, i.e., is it low, high, or moderate and expected (likely) actions of
competitors?
ƒ Competitive actions taken by competitors.
ƒ Competition strategy adopted by competitors.
Quality,
Product Assortment/Differentiation,
Pricing,
Advertising, etc.
Distribution Structure:
ƒ Geographic distribution of sale.
Local: Regions, Zones, and, if possible, Woredas and Kebeles.
Foreign: In which nations or geographical zones (specifically identify foreign market zones).
ƒ Distribution channels (assess existing distributors and channels).
Retailers;
Wholesalers;
Sales agents;
Transport channels (air, water, rail, road, etc).
ii. Customer Analysis and Market
Segmentation Objective of making customer analysis:
ƒ To identify customers’ needs and behaviors in the market.
It is the main basis for subsequent decisions.
ƒ To design ultimately the marketing mix most likely to fit with (or satisfy) the needs of customers in the market.
Items to be analyzed include:
 Product/service “Demand” in the market;
  Purchasing “Motive” of customers;
 Who the “Buyers” are;
 Purchasing “Practice” (continuous, seasonal, etc);
 Purchasing “Quantity and Frequency”; and
 Purchase “Location” (how similar products are currently marketed and what the customers actually need with
respect to marketing/buying location?
Analysis may be conducted for the market as a whole or for a market segment depending on the nature of the product
and the significance of the assessment for the project. A market segment is characterized by the following features
(or conditions):
 It is distinct from other markets,
 It has customers having relatively uniform behavior, and
 The size must be big or large enough to warrant special attention of marketers and provide adequate/enough
profitability as a return.
There are different bases for segmentation of market. The following are among the various bases for market
segmentation:
 Geographic,
 Linguistic/Cultural,
 Socio-Demographic structure (age, sex, income, social class), and
 Psychological/Status in the society.
Life style, motive, sensitivity to price/promotion.
Ambition, leadership (lead users), etc.
iii. Analysis of Distribution Channels
Identify available distribution channels:
 Sales distribution companies (wholesalers).
Benefits versus costs;
Advantages versus disadvantages; and
Product specific requirements.
 Retailers.
 Personal selling.
 Sales agents.
 Direct to customers selling.
iv. Analysis of Competitors
Items to be analyzed and/or considered in the analysis of competitors include the following:
 Who are the competitors in the market?
 Strengths/weaknesses of competitors in the marketing mix (i.e. in the 4 P’s).
 Total sales level of competitors (quantity and value).
 Target market served by competitors.
Limited/segment(s); and/or
Wide spread/large coverage.
 Competitors’ sales level in the target markets.
 Market share of competitors.
 Marketing expenditures of competitors for promotion & distribution purposes.
  Possible actions to be taken by competitors as a reaction/against new entrants.

ƒ v. Analysis of Socio-Economic Environment

The major objective of the analysis of socio-economic environment is to determine the socio-economic aspects
relevant to the preparation and evaluation of the project's marketing strategy.
ƒ These, among others, constitute cultural and socio-economic aspects (such as income, age, education,
religion, urban-rural configuration, social class, values, norms, etc) that affect the projects strategy in the
market).
vi. Internal Analysis
The basic objective of making internal analysis is to identify the existing strengths and weaknesses in the internal
environment of the business firm. This is particularly relevant for currently existing organizations/firms (i.e. ongoing
organizations/ firms in operation) that are planning to expand production capacity, modernize plants, and/or diversify
investments.
 Products and production process [quality, feature, warranty, technology, plant, human resource skill, core
competence, etc].
 Marketing – (strategies & mixes).
 R & D – experience, contribution, funds, professionals, etc.
 Financial liquidity, solvency, profitability (BEP, ROA, ROE, etc); reserve capacity for borrowing; etc.
 Personnel skill, expertise, commitment, etc.
 Management and organization – style, flexibility, orientations, strategies, & strategic plans & actions. vii.
Projecting Marketing Data
Projected market data are the fundamental outputs of the marketing research and are the basic/tangible inputs for the
next series of preparation aspects in project planning.
ƒ Indicate qualitative & quantitative data and/or variables that are necessary for making revenue projections.
The following considerations should be made:
ƒ The existing characteristics of Supply and demand in the market and the level of unsatisfied demand
(existing as well as potential).
ƒ Market share to be achieved [estimated].
Use forecasting techniques (incorporate both quantitative and qualitative data in the forecasting model). In other
words, our forecasting model should accommodate both quantitative data and qualitative information.
5.3. Extent and Comprehensiveness of the Market Research
The extent of the market research and the comprehensiveness of its outcomes depend on the following two aspects:
ƒ The complexity of each of the problems listed under (i-vii) above. [It may be broad/extensive or narrow/
simple]; and
ƒ Its significance for the project and project preparation.
5.3.1. Data Collection and Analysis
The data required for the market research may be collected through field surveys, desk research (i.e. secondary data
sources), or both.
ƒ Field Survey: such as interviews, tests, observation, etc (primary sources of data).
ƒ Desk Research (secondary sources of data):
Information contained in statistical and other reports originally prepared for other purposes.
Relevant written materials, internal or external, should be collected and analyzed.
In this regard, the analyst needs to distinguish between general statements for the market as a whole and specific
data for a market segment.
5.3.2. Dimensions of the Market and Demand Analysis
The general list of major dimensions of the demand and market analysis should cover the following aspects:
A. General Characteristics of the Economy
Major Aspects:
 Economic potential,
 Production structure,
 Foreign trade, and
 Economic policy.
Relevant Items of Analysis:
The general indicators of economic potential and activity are necessary in order to put further as well as more
detailed considerations in the proper framework. The level of economic welfare and dynamics of economic
development will serve as an important indicator of the character and intensity of demand. The existing production
structure and trends in these structures’ changes may suggest present and potential classes of products required in
the market, their technical advancement, and quality.
The same is true for foreign trade analysis, which also or, perhaps, first of all, indicates the country’s “openness” to
the outside world. In case of export market analysis, a number of problems concerning market accessibility, together
with specific terms and conditions of operating in the foreign market, freight and insurance aspects, as well as terms
of delivery and payment should be added to the list. The economic policy analysis will show the level of
government support and protection that local producers may expect to enjoy.
B. Product:
Major Aspects:
ƒ Characteristic features,
ƒ Substitutes and complementary goods, and etc.
Relevant Items of Analysis:
The product to be marketed should be introduced covering all its properties and characteristics, advantages and
disadvantages, and types and qualities. Moreover, information about substitutes and complementary products
provide valuable inputs for the marketing strategy to be designed or for demand and sales forecast. A clear
awareness of which group the project’s product belongs to is necessary to define the scope of demand and market
analysis and to understand the characteristic features of the analyzed market.
National markets, which are the most typically used geographic dimension of the study, are almost never
homogenous. After analyzing the total market, its segmentation, therefore, should be performed. That is, a number
of sub-markets (segments) should be distinguished, characterized by greater homogeneity with respect to features
significant from the point segment members’ market responses.

Consumers differ often markedly in income, demographic features, sociological, and psychological features.
Therefore, effective market segmentation:
 Helps to understand better market behavior and responses;
 Enables the concentration of efforts on promising market segments;
 Enables the fine turning of marketing strategy to the needs of target segments; and
 Helps to increases total sales, reduce costs, and step up profits.
The major variables based on which markets can be segmented, among others, are geographic setting, socio-
economic variables, and personality & behavior.
ƒ Geographic Variables: such as administrative regions, geographic regions, climate, city – size, rural district
– size, etc.
ƒ Socio-Economic Variables: such as income, age, sex, occupation, education, family size, religion, nationality,
social class, and culture.
ƒ Personality and Behavior: such as life style, leadership, ambition, buying motive, service sensitivity, and
sensitivity to promotions.
Several of the above variables can be used to perform an effective segmentation of a particular market. Their choice
depends on the character of the product and purpose of analysis. However, one should not be tempted to employ too
many segmenting criteria bearing in mind that the resulting segment should be:
 Large enough to obtain sufficient sales & profit,
 Accessible through the existing channels, and
 Measurable in terms of costs and benefits.
Since criteria for segmentation of markets differ from product to product, it is not possible to design guidelines as to
their nature and structure, but it is necessary to define such elements in feasibility study for a particular product. In
some cases, such as dairy products, a large national market may regionally be divided; in other cases, such as for
steel, aluminum, or paper industries, the market limits may extend beyond national frontiers.
C. Demand
Major Aspects:
 Sales and orders,
 Buyers’ characteristics,
 Demand determining factors, and
 Purchasing power.
Relevant Items of Analysis:
Demand is the quantity of goods that buyers are ready to purchase at a specific price in a particular market at a
given point of time. The critical factor in demand and market analysis is an estimate of the demand for a specific
product(s) during the life span of a proposed project, keeping in mind that the viability of the project is dependent,
among other things, on the projected sales.
The size of the demand, at any given time, is a function of several variables (factors) such as:
 Population and income levels,
 Development trends,
 Price level and tendency,
 Income and price elasticity of demand,
  Technology,
 Availability and prices of substitutes and complementary products,
 Buyers expectation with regard to the future economic situation,
 Their behavioral patterns and a number of other market forces as well as legal and political factors, etc.
An inadequate or inaccurate analysis of the demand growth pattern, market potential, and expected market share
usually results in either excess production and poor capacity utilization, as is often the case in developing counties,
or plant capacity that is insufficient to meet market needs and unable to take advantage of economies of scale.
The point of departure in demand analysis is the determination of current effective demand, the basis for the
estimation of which is the actual consumption figure during the relevant period. Still, it may not be easy to obtain
consumption figures for most products. A beginning has to be made with “apparent consumption” of a product,
which, for a domestic market, is arrived at, for a given period, by aggregating its production and deducting or
adding the changes in the balance of trade and in inventories.
Thus, for a domestic market, the apparent consumption (C0) for a given period is given by:
C0 = P + (I – E) + (So – S1)

where:
P = the production during the period; I
= the imports
E = the exports
S0 = the level of stocks at the commencement of the period, and
S1 = the level of stocks at the close of the period (changes in the stock level)
In a competitive market, apparent consumption can be equated with current effective demand but not in most
developing countries, as there are various restrictions on consumption and imports of manufactured goods. In
estimating the demand for a product, it is necessary to allow for various factors that might have remained
suppressed through rationing or exchange restrictions. The amount allowed will depend on each individual product,
the nature of the market, and the size and structure of the industry.
Another possible factor is the existence of monopolistic or oligopolistic imperfections restricting domestic
production by plan target or the non – availability of inputs, domestic or imported. The present effective demand for
a given year, in this regard, may not be representative to the market under study. Therefore, it must be compared
with demand development trend and its dynamics.
Detailed analysis of the characteristics features of buyers and their purchasing power, total and in segment
breakdown is necessary to precisely estimate sales and develop marketing strategy to satisfy target segments. This
should be combined with the study of factors determining demand, which will have significance in understanding
the character and changes in demand for a given product, construction of demand models, and demand forecasting.
D. Supply
Major Aspects:
 Supply potential,
 Local production,
 Imports and exports, and
 Competitors’ position.
Relevant Items of Analysis:
In addition to the analysis of the characteristics of demand, it is also important to assess the characteristics and
features of supply in the study of market & demand analysis. This contributes to defining product’s or the
company’s competitive position in the market as well as examine demand/supply balance. Although the competitive
position can only be described comprehensively when aspects of marketing are included, a physical description of
domestic supply is an inevitable first step.
The analysis of supply should include, inter alia, the following factors:
 Number of producers;
 Production program;
 Existing capacity;
 Plants under construction;
 Capacity utilization;
 Output/sales;
 Market shares;
 Production costs;
 Technology applied;
 Age of equipment;
 Location; etc.
The local producers’ past and present output, together with capacity utilization review provides a convenient
departure point for the analysis of supply situation combined with demand estimates, in turn, to determine the
project’s position in the market and, therefore, expected sales.
Local production should be correlated with the balance of foreign trade in a particular commodity under study
considering the absolute size of exports, imports, and their trends. Firstly, a high import volume combined with
local producers´ full capacity utilization may indicate surplus of demand over local supply capacity or, if the export
volume is correspondingly high, it implies the existence of foreign markets more rewarding to the local producers
than the domestic one. Secondly, low or negligible import volume is not necessarily an indication of internally
balanced market, particularly in the presence of strict import control measures.
In both cases, the future position of the new project appears promising, although a very thorough analysis of
demand is called for in the second case. If, however, a high import volume accompanies a low level of local
capacity utilization, the project under study will only be viable if its products can effectively compete with imported
items in terms of quality, price, and other elements of marketing strategy. Unless a substantial amount of market
protection may be expected.
E. Marketing Environment (marketing strategy, marketing mix, etc)
Major Aspects:
 Price levels and tendencies,
 Distribution channels,
 Physical distribution network, and
 Promotion.
Relevant Items of Analysis:
Further improvement in establishing a project’s expected position in the market will be achieved through studying
the elements of Marketing Environment. There is a tendency to associate marketing – mix variables
with effective decision making and, thus, postponing the collection and analysis of relevant information until much
later operational phase of project development. It is true that most decisions regarding marketing management will
be called for when the project becomes operational. It is, nonetheless, also true that marketing strategy will have a
decisive influence on expected sales levels and revenues, which have to be forecasted at this stage.
In general, no matter what the envisaged project’s position vis-à-vis competition, broad marketing strategy should
be developed at this stage in order to arrive at meaningful sales volume and forecasts of sales revenue. Against this
background, an analysis of the existing marketing environment has to be carried out. This offers further insight into
the determinants of competitiveness. From the marketing point of view, competitiveness is not just a matter of
pricing as frequently assumed. In fact, it is determined by three more factors that in aggregate comprise the
marketing mix or the 4Ps.
The variables that constitute the marketing mix, in this regard, are Price, Product, Place (Distribution), and
Promotion as mentioned earlier in this chapter. Each of the marketing mix variables is discussed below.
Price:
The determination of product price levels is part of both the basic project strategy and the long-term marketing
strategy. In this regard, relatively low quality products usually need a low-price strategy; while a high-price strategy
would require a higher performance level in terms of product quality, design, warranties, brand names, and services.
The following are some of the major aspects related to price and pricing:
 Price level;
 Income, price, and substitution elasticity of demand;
 Pricing methods (cost-plus pricing, marginal cost-pricing, price differentiation, discounts);
 Regulations for pricing;
 Payment conditions; and
 Financing conditions.
For the determination of sales prices, the internal production and marketing costs, customer reactions to different
prices (price elasticity), and the price policies of competitors must be considered.
Items that need be assessed when determining the price policy include:
 Profit Margins of wholesalers and retailers;
 Existence of public price controls;
 Discount policy; and
 Delivery and payment conditions.
Product:
An investment project is only financially feasible when the project’s outputs have a value for the consumers, in
other words, when the product can be sold on the market. In the feasibility study, it should be investigated whether
the project better concentrates on a single product or a range of (different) products. The product mix should be
designed to meet the needs and preferences of the customers. The basic product related aspects are the following:
 Production mix
 Product development strategies
 Design and fashion
 Brand name
  General image building
 Packaging
 Labeling service
 Warranty terms
 Legal aspects (i.e. regulations regarding health & safety issues, and so on)
The determination of the characteristics of products and the outlining of a policy are the basis for the production
program and plant capacity, the engineering design, the projection of investment, production, and marketing costs,
as well as the evaluation of the market risks against possible marketing strategies.
Place (Distribution):
Distributions from the factory through wholesalers to retailers, through retailers, or directly to consumers are the
main distribution channels used by producers to reach the end users. This aspect generally includes the following:
ƒ Distribution channels; and
ƒ Logistics (transport, storage).
Therefore, the combination of the above controllable marketing variables (aspects) must be determined with regard
to the customers or end-users as well as the distribution channels. Product, price, promotion, and distribution – i.e.
the marketing mix variables – must be seen as interdependent marketing tools that need to be combined in a way to
enable the envisaged plant achieve its marketing objectives.
Promotion (Promotional Mix):
Promotional measures will be required for the investment project in order to help the firm enter in to a given market
or different markets with new product(s), and stay in the market and reach the long term objective of the project.
The promotional tools, often referred to as promotional mix, include the following:
 Advertisements (helps to stimulate demand);
 Public relations;
 Personal selling;
 Sales promotion; and
 Publicity.
The feasibility study should identify the promotional measures required to be undertaken in order to reach the
projected sales volume as well as estimate the costs of these measures.
6. Legal and Political Environment
Assessment of the legal & political environment is also an important task in the course of feasibility studies. In this
regard, regulatory issues like those associated with product safety, branding, environmental impacts, health issues,
and the potential legal liabilities should be taken in to account in the preparation of an industrial project. In addition
to this, the influences of the changes in the political environment, both positive and negative, opportunities existing
for lobbying, and the effects of new political directions, strategies, etc should be taken in to consideration.
5.3.3. Summary of Aspects in the Market and Demand Analysis
It is to be recalled that demand is defined as the existing willingness and ability to acquire something, (goods or
services that buyers are ready to purchase at some time). In other words, demand represents the quantity of goods
that buyers are ready to purchase at a specific price, in a particular market, and at a given point of time (may be in
the current period, in the short-run or long-run period, etc).
 On the other hand, sales indicate the quantity of products actually purchased by buyers at a specific price, under
specific marketing strategy, in a particular market, and at a given point in time. Determining the level of “Apparent
Consumption” (Co), in this regard, is the primary concern of the analyst in the course of analyzing the pattern of demand
and supply (or sales). Although the level of apparent consumption is said to be a good starting point for such analysis, it
is often difficult to get structured (readily available) consumption data.
Moreover, even if we have the apparent consumption figure, still it may not represent the current effective demand
for a given product. The discrepancy occurs, inter alia, due to the following factors:
ƒ Existence of suppressed demand due to rationing: [limit on the consumption of some products or exchange
restrictions on foreign currency transactions, for instance, in consuming scarce resources like fuel, power,
etc];
ƒ Import restrictions on importable manufactured goods;
ƒ Excessive import duties [ e.g. on automobiles and luxuries];
ƒ Existence of monopolistic or oligopolistic imperfections; etc.
Apart from the above variables, the lack/shortage of foreign currency can also create such a discrepancy. For
instance, consider the situation in Ethiopia in the year 1999 E.C., where importing cement is only allowed to
investors on “Franco Valuate” basis. “Franco Valuate”, in general, indicates an arrangement whereby only
investors having their own foreign currency deposits, which is either obtained from exports or some other foreign
transactions (sources), are allowed to import such items with out requiring purchase of additional foreign currency
and/or use of the nations foreign currency deposits];
Finally, it is also important to distinguish between industry sales, project sales, and current effective demand. In this
regard, it should be recognized that the balance of the industry sales will practically be equal to the effective
demand in the absence of the above restrictions, market anomalies, and supply shortages. However, a project’s sales
may be substantially smaller than the demand in the given market depending on the projects’ capacity, marketing
strategy, and position (market share) vis-à-vis competitors.

Exhibit 5.1: Summary of Dimensions and Items of Analysis

No. Dimensions Relevant Items Of Analysis

ƒ Economic welfare and dynamics of economic development (in order to

identify the character and intensity of demand);
ƒ Existing industry structure;

General Economic ƒ Existing production structure and trends/changes (Present and potential
i and classes of products needed; Technical advancement and quality; etc).
Business Condition ƒ Foreign trade (structure, growth rate);
ƒ GNP/GDP (by industry, sector, and growth rate);
ƒ Inflation level and trend; and
ƒ Foreign exchange position (balance of payment).
Economic ƒ General economic policy;
and
ƒ Investment policy and incentives;
Business Policy
ii ƒ Industrial policy;
(In order to see the level of government
support given and protection of local ƒ Foreign trade policy;
producers)
ƒ Tax policy; etc.
 Product ƒ Properties and characteristics of the new product to be introduced;
(The basic questions addressed are to ƒ Advantages and disadvantage of the new versus
which group does the project’s product existing products.
iii belong/delivered? Which segment should
ƒ Types and qualities (new versus existing); and
be served? This helps to define the scope
of demand and market analysis and ƒ Substitutes and complementary products (in order to design marketing strategy and
understand the characteristics of the make demand & sales forecast).
analyzed market.)

Demand ƒ Population and income levels (existing level and future/forecasted size of
(The purpose is to assess the current
population);
effective demand, that is, the actual demand ƒ Development trends & projections (that is, GDP);
that people need to satisfy. It is estimated
based on the level of apparent consumption, ƒ Price level and tendency;
i.e. the C0 is adjusted ƒ Income and price elasticity of demand;
iv.
upward in order to derive and/or estimate ƒ Technology (currently in use, advancements, modern technologies/new versions);
the current effective demand.)
ƒ Available technologies, recent breakthroughs, obsolescence of existing ones, etc.
ƒ Availability and prices of substitutes and complementary products;
ƒ Buyers expectations regarding future economic situation; and so on.
ƒ Supply potential of competitors

Supply ƒ Amount of local production

The purpose is to define the product’s or ƒ Imports, exports, and balance of foreign trade;
the company’s competitive position in the ƒ Implications of high import volume and full capacity utilization of local
market. Supply refers to producers; low or negligible import volume (is not necessarily an indication of
v. competitors’ products or services internally balanced market); high export volume, the same item being imported;
currently supplied in the market; and the high import volume accompanied by low domestic capacity utilization
study of supplies helps to decide whether
to enter such markets or not.) ƒ Competitors’ position

Marketing Environment ƒ Marketing expenditure;

vi. (Marketing strategies; intensity of ƒ Competitive strategy; and
competition; and so on.)
ƒ Marketing mix (4ps).

ƒ Safety issues,
Legal and Political Environment
vii. ƒ Branding issues,
ƒ Environmental and health issues, etc.

5.4. Findings and Conclusions of the Market Research

5.4.1. Outputs of the Market Research
The findings and conclusions in the marketing research:
 Delineates market opportunities,
 Delineates market risks (threats), and
 Enables the concerned make forecast of sales.
In addition to this, the findings of the market research have significant implications and forward linkages with the
basic aspects of the project in that it provides inputs for the:
ƒ Development of marketing strategy;
ƒ Final selection of project scope with respect to:
Plant capacity,
Material inputs,
Location,
Engineering “Science” and technology “Art” aspects,
Human resource aspects, and
Management and organization.
ƒ Financial evaluation and process of appraisal – i.e. financial feasibility and/or profitability assessment.
5.4.2. Projection of Sales Revenue
The projection of sales revenues is essentially an extension of marketing research, (i.e. it is made in light of the
outputs in the market and demand analysis). On the basis of which, the project’s sales will be developed in terms of
specific sales volume expected during the different periods after the project goes into production.
A. Factors to be Considered in Forecasting Sales
Estimating sales revenue is an iterative process that should take into account the optimal plant capacity, appropriate
technology, a technically feasible production program, and alternative marketing strategies. The final determination
of sales revenue, therefore, may only be possible once technology and plant capacity are more clearly known. In
this regard, the project planner should feed the technology concept into the sales and marketing program in order to
harmonize both and to outline the production program.
Projections of sales can only be made according to the market structure, market requirements, and marketing
strategies that are followed. Marketing strategies, in this regard, need to be defined and assessment should be made
with respect to the implications in terms of product pricing, production program, promotional efforts, and the sale
& distribution mechanisms. Only then can a reasonable projection be made of the likely annual sales (in units) and
the revenue from such sales.
Briefly, the underlying factors that affect the size of sales revenue are summarized below, which the analyst need to
consider while forecasting sales:
ƒ Plant capacity and production program.
ƒ Marketing strategies that comprises the following:
Marketing Expenditure,
Marketing Mix (or the controllable marketing variables), and
Competitive Strategies (Cost, Quality, Delivery Performance, and Flexibility & Customer Service).
ƒ Production technology: Capital versus Labor intensive, Computerized versus Manual, etc.
ƒ Project life (estimated economic life of the project).
ƒ Market price of product(s) – expected selling price (note that price is among the marketing mix variables).
ƒ Export/Import sales by competitors.
ƒ Expected Export/Local sales by the project; etc.
 B. Sales Value (Revenue)
The alternatives in determining the amount of sales revenue should be identified as follows:
ƒ Gross sales value (including the amount of sales tax); and
ƒ Sales value (net of sales taxes).
In this regard, while estimating the level of sales revenue and/or developing the sales program, it must be decided
in advance whether to include the sales tax, which can become a rather important cost item. If the sales tax is
included in the sales revenue, it has to also be incorporated in the production costs. This ensures tax is both counted
as cash inflow (as part of sales revenue) and as cash outflow (as part of the production costs) and, thus, it cancels
out. [Note that sales tax is payable by the ultimate consumers (customers), which is collected by the seller and
remitted to the Inland Revenue Authority.]
In general, considering the foregoing factors as well as aspects of sales revenue, you need to identify the various
sequential steps that are involved in the due process of sales projections. The sequence of activities (or steps)
involved in projection of sales are as depicted in Exhibit 5.2 below:
Exhibit 5.2: Steps for Sales projection

A. Demand Estimates

B. Supply Potential Estimates

C. Project’s Marketing Strategy

D. Expected Competitors’ Strategies, (if

E. Sales Projection

C. Marketing Costs
In addition to sales revenue, the associated marketing costs should be estimated and/or accounted for, being
classified in terms of their variable and fixed cost components. The classification of the marketing costs in to
variable and fixed portions, among other things, has its own significance in analyzing the relevant costs and making
sensitivity analysis for the project. The following are examples of the marketing costs that are classified as variable
and fixed:
ƒ Variable components – advertisement, promotion, commissions for brokers/agents, etc.
ƒ Fixed components (with in a given relevant range) – salespersons basic salaries (monthly/annual), depreciation of
vehicle, etc.
5.5. Demand Forecasting (Projection) Methods

5.5.1. Techniques of Demand Forecasting

After gathering information about various aspects of the market and the marketing environment in general and data
obtained from primary and secondary sources in particular, attempt may be made to estimate future demand. In this
regard, the projection of future demand for a given product or service, apart from requiring critical analysis of raw
market data, needs to be made using appropriate forecasting model and/or techniques.
Generally speaking, the chosen model should allow the analyst in order to incorporate both qualitative and
quantitative data in formulating the forecast equation. With regard to model alternatives, there are different
forecasting methods and/or techniques available to the market analyst. However, for the purpose of this material as
well as the sake of clarity, the various forecasting methods may be classified in to three major categories as
Qualitative Techniques, Time Series Techniques, and Causal Methods.
A. Qualitative Methods:
These methods rely essentially on the judgment of experts to translate qualitative information in to quantitative
estimates. The important qualitative methods are:
ƒ Jury of Executives Opinion technique, and
ƒ Delphi Method.
B. Time Series Projection Techniques:
These methods generate forecasts based on an analysis of data over the historical time series. The main time series
methods of projection are:
 Trend Projection Method,
 Exponential Smoothing Method, and
 Moving Average Method.
C. Causal Methods:
With more analysis than the preceding methods, causal methods seek to develop forecasts based on cause-effect
relationships specified in an explicit, quantitative manner. The following are the major causal methods:
 Consumption Level Method,
 End use [or Consumption Coefficient] Method,
 Leading Indicator Method,
 Chain Ratio Method, and
 Regression Model
5.5.2. Qualitative Techniques for Demand Forecasting
A. Jury of Executives Opinion Method:
This method, which is very popular in practice, involves eliciting the opinions of a group of managers with respect
to the level of future sales expected for a given product and then combining the estimates to determine sales for the
period under forecast.
Advantages:
The advantages of this method are the following:
 It is an expeditious method for developing a demand forecast.
 It permits a variety of factors, like economic climate, competitive environment, consumer preferences,
technological developments, and so on, to be included in the subjective estimates provided by the experts.

 It has immense appeal to managers who tend to prefer their judgment to mechanistic forecasting procedures.

Disadvantages:
The disadvantages of this method, however, are the following:
 The biases underlying subjective estimates cannot be easily eliminated.
  The reliability of this technique is questionable.
B. Delphi Method
This method adopts a technique for eliciting the opinions of a group of experts with the help of a mail survey.
The steps (procedures) involved in this method are the following:
ƒ A group of experts is sent a questionnaire by mail and asked to express their views,
ƒ The responses received from the experts are summarized, without disclosing the identity of the experts, and
sent back to the experts, along with a questionnaire meant to probe further the reasons for the extreme views
expressed in the first round,
ƒ The process may be continued for one or more rounds till a reasonable agreement emerges in the views of
the experts.
The Delphi demand projection technique appeals to many organizations for the following reasons:
ƒ It is intelligible to users, and
ƒ It seems to be more accurate and less expensive than the traditional face-to-face group meetings.
However, it may be time taking for reaching on common consensus and hence, the final estimate under this
technique.
5.5.3. Time Series Techniques for Demand Forecasting
A. Trend Projection Method:
The trend projection method involves the following two major activities:
ƒ Determining the trend of consumption by analyzing past consumption statistics, and
ƒ Projecting future consumption by extrapolating the trend.
When the trend projection method is used, the most commonly employed relationship is the linear relationship,
which is expressed by the following equation:
Yt = a + bT

where,
Yt = demand for year t,
T = time variable,
a = intercept of the relationship (constant), and
b = slope of the relationship.
To estimate the parameters “a” and “b” of the linear relationship, the least square method is used. According to the
least squares method, the linear relationship is chosen in such a manner that the sum of the squared deviations of the
2
observations from the line, [i.e. Σ (y – a – bT) ], is minimized.
The equation for “a” and “b” is derived as follows:
ƒ First, identify the equation showing the sum of the squared deviations.
 2
It is Σ (y – a – bT)
ƒ To minimize this equation with respect to “a” and “b”:
Differentiate the sum of the squared deviations with respect to “a” and “b” and set the partial
derivatives equal to zero.
This gives:
2
∂Σ/ ∂a (y-a-bT) = -2Σ (y – a – bT) = 0
= Σ (y – a – bT) = 0
= ΣY = Σ (a + bT) = 0 ……………………………………. (Equation 1)
2
∂Σ/∂b (y –a - bT) = - 2TΣ (y – a – bT) = 0
2
= Σ (Ty –Ta – bT ) = 0
2
= ΣTY = Σ(aT + bT ) = 0 ……………………………………….….… (Equation 2)
ƒ Solving these two equations, referred to as normal equations, we get the values of “a” and “b” given in
equations below:

b = ΣTY – nT Y
2 2
ΣT – nT
_ _
a = Y – bT

where,
T = ΣT/n
Y = ΣY/n
n = number of observations
Exercise:
Based on the historical data given below, which is pertaining to the annual demand for a given product, try to
develop the least square linear function to be used in order to forecasting demand as per the trend technique as well
as determine the level of demand expected in the year 2002.
Exhibit 5.3: Trend Demand Figures

Year 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Demand
10 13 14 17 18 18 19 20 22 23 22 24 24 25
(in ’000 Units)

Computations:
For purposes of linear trend analysis, you need to consider the first period in the trend as the base year, which is
year 1988 in this case, and give it a value of zero. Then, convert the subsequent actual years in to a form suitable for
analysis, in this regard, by sequentially numbering as 1, 2, 3, up to "n". See the computations in Exhibit 5.4 below.
Exhibit 5.4: Trend Technique
2
Actual Year Year for Analysis Demand (’000) TY T
[Time] (T) (Y)
 1988 0 [Base Year] 10 0 0
1989 1 13 13 1
1990 2 14 28 4
1991 3 17 51 9
1992 4 18 72 16
1993 5 18 90 25
1994 6 19 114 36
1995 7 20 140 49
1996 8 22 176 64
1997 9 23 207 81
1998 10 22 220 100
1999 11 24 264 121
2000 12 24 288 144
2001 13 25 325 169
ΣT=91 ΣY = 269
2
_ _ ΣTY = 1998 ΣT = 819
T=6.5 Y = 19.21

b = ΣTY – nT Y
2 2
ΣT – nT

= 1998 – (14x6.5x19.21)
819 – (14x6.52)
= 1998 – 1748.5
819 – 591.5
= 1.097

a = Y – bT
= 19.21 – (1.097 X 6.5)
= 12.08
Therefore, the linear equation applicable for the trend forecasting is Y t = 12.08 + 1.097T. Using this equation, the
demand for the year 2002 is determined as follows:
Y14 = 12.08 + 1.097 (14)
= 27.438 units (figure in ’000)
B. Exponential Smoothing Method
In exponential smoothing, forecasts are modified in the light of observed errors. In this regard, the following are the
guiding principles:
ƒ If the forecast value for year t, i.e. Ft, is less than the actual value for year t, i.e. St, then the forecast for the
year t + 1, i.e. Ft + 1, is set higher than Ft.
ƒ Conversely, if Ft > S t, Ft + 1 is set lower than Ft.
In general,
Ft + 1 = Ft + αet
where,
 Ft + 1 = forecast for year t + 1,
α = smoothing parameter (which lies between 0 and 1), and
et = error in the forecast for year t, which is obtained as St – F. How
should the first forecast (F1) and the smoothing parameter (α ) be chosen?
ƒ A simple and reasonably satisfactory rule of thumb is to choose F 1 as the mean of the warm-up sample.
(The warm-up sample consists of several observations preceding the period for which the forecasting
exercise is began).
ƒ For choosingα , consider several values in the range of 0 to 1 and choose the value that minimizes the MSE
(Mean squared error) in the warm-up period. The mean squared error is defined as:
1
n = ∑ (Si – Fi)
2

where,
Si = actual value of sales in period i,
Fi = forecast of sales in period i, and
n = number of periods in the “warm-up’’ sample.
Exhibit 5.5: Exponential Smoothing Graph
DD

::::::::: ::::::
:::::: :::::
… :::::::::::::
:::::::::::::::::::::
:::::::::::::
:::

Year

For simplicity of using the exponential smoothing method, in this text, it is assumed that we know the value of F 1
andα . However, you may sometimes be required to determine the values of F1 andα .
Example 1:
Assume that the actual sale of a given product in period 1 is 28,000 units while the forecasted sale is 29,000 units
for the initial period. Assume further that the actual sales value for the next ten periods is the following:
Exhibit 5.6: Actual Sales Data

Period 2 3 4 5 6 7 8 9 10 11
Sales (‘000 Units) 29 28.5 31 34.2 32.7 33.5 31.8 31.9 34.3 35.2

Given α = 0.2, derive the forecast of sales for the next 10 periods.
Solution [Figure in ‘000 of Units]
 Exhibit 5.7: Exponential Smoothing Method
Data Forecast Error Forecast for t + 1
T (St ) ( Ft ) (et = St – Ft) (Ft + 1 = Ft + α et)
1 28 29 -1 F2 = 29 + 0.2(-1) = 28.8
2 29 28.8 0.2 F3 = 28.8 + 0.2(0.2) = 28.8
3 28.5 28.8 -0.3 F4 = 28.8 + 0.2(0.3) = 28.7
4 31 28.7 2.3 F5 = 28.7 + 0.2(2.3) = 29.2
5 34.2 29.2 5.0 F6 = 29.2 + 0.2(5.0) = 30.2
6 32.7 30.2 2.5 F7 = 30.2 + 0.2(2.5) = 30.7
7 33.5 30.7 2.8 F8 = 30.7 + 0.2(2.8) = 31.3
8 31.8 31.3 0.5 F9 = 31.3 + 0.2(0.5) = 31.4
9 31.9 31.4 0.5 F10 = 31.4 + 0.2(0.5) = 31.5
10 34.3 31.5 2.8 F11 = 31.5 + 0.2(2.8) = 32.1
11 35.2 32.1 3.1 F12 = 32.1 + 0.2(3.1) = 32.7
Example 2:
Assuming the actual sales data in Example 1 above, determine F 1 andα if the number of periods for the warm-up
sample is 4 and the forecast errors during this period being -1, 0.2, -0.3, and 2.3.
Solution:

1. = S1+S2 +S3+S4
F1 4
28+29+28.5+31
F 1= 4 = 29.125 ≈ 29

2. α is the value that minimizes the mean squared error. The mean squared error, in this regard, is computed as:

1
n =∑ (Si – Fi)
2
.
∑(Si – Fi) 2 = -12 + 0.22 - 0.32 + 2.32
=6.42
¼ = α X 6.42/4
α ≈ 0.2
C. Moving Average Method
As per the moving average method of sales forecasting, the forecast for the next period is equal to the average of the
sales for several preceding periods. In this regard, if “S” represents actual sales of a given product and “F”
represents its forecasted level, then the moving average formula can be written in the form:
F t + 1 = S t + S t – 1 + S t – 2 + ……. + S t – n + 1
N

where,
Ft + 1 represents forecast for the next period,
St represents actual sales for the current period, and
 n represents the number of periods over which averaging is done.
Example:
Consider the following trend sales data [figure in ‘000 of units]:
Exhibit 5.8: Actual Sales Data
Year Sales
1 28.0
2 29.0
3 28.5
4 31.0
5 34.2
6 32.7
7 33.5
8 31.8
9 31.9
10 34.3
11 35.2
12 36.0
Assuming the forecaster has set “n” to be equal to 4, make a forecast of sales for the periods 5 through 12.
Solution

28+29+28.5+31
F5 = 4 = 29.1

F = 29 + 28.5 + 31 + 34.2 = 30.7

6
4
F = 28.5 + 31 + 34.2 + 32.7 = 31.6
7
4
F = 31 + 34.2 + 32.7 + 33.5 = 32.9
8
4
F = 34.2 + 32.7 + 33.5 + 31.8 = 33.1
9
4
F 32.7 + 33.5 + 31.8 + 31.9 = 32.5
=
10
4
F = 33.5 + 31.8 + 31.9 + 34.3 = 32.9
11
4
F = 31.8 + 31.9 + 34.3 + 35.2 = 33.3
12
4
5.5.4. Causal Methods for Demand Forecasting
A. Consumption Level Method:
This method estimates consumption level based on elasticity coefficients, the important ones being the income
elasticity of demand and the price elasticity of demand. This method is useful for forecasting the demand for a
product that is directly consumed.
 1. Income Elasticity of Demand
It reflects the responsiveness of demand to variations in income. It is measured as follow:
Q 2– Q 1 X I1 + I 2
EI =
I2 – I1 Q2+Q1
where,
EI = income elasticity of demand,
Q1 = quantity demand in the base year,
Q2 = quantity demand in the following year,
I1 = income level in the base year, and
I2 = income level in the following year
Then, demand is computed as follows;
Per capita Per capita change
Change in = in income level X EI
Demand (percentage)

Projected Per Present Per Per Captia

Capita Demand for year n = Captia Demand X 1+ Change in Demand

Total Demand Projected per Projected population

Projection for year n = capita demand X level in the country
for year n for year n
Example 1:
The following information is available on quantity demanded and income level (for periods 1 and 2): Q 1 = 50, Q2 =
55, I1 = 1000, I2 = 1020. What is the income elasticity of demand?
The income elasticity of demand is:
EI = 55–50 X 1000 + 1020
1020 - 1000 55+50
= 4.81
Example 2:
Based on the given data, answer the questions that follow:
Given:
 Present Per capita annual demand for a certain product is 1 kg.
 The present per capita annual income is birr 1000.
 The income elasticity of demand (EI) for the product is 2.
 Per capita annual income three years from now is expected to be birr 1200 in real terms.
 The total population is estimated to reach 100 million in three years.
What would be the projected per capita demand for the product three years from now?
 It would be obtained as follows:
Per Capita change =
birr 1200 – birr 1000 x 2
in demand in yr 3 birr 1000
= 0.4
Projected per capita demand for year 3 = (1 + 0.4) x 1 kg
= 1.4kg

What would be the aggregate demand for year 3?

• The projected total demand would be equal to: 1.4kg X 100 million, (which is 140 million kg).
2. Price Elasticity of Demand
It measures the responsiveness of demand to variations in price. It is computed as:
Ep = Q – Q2 1 X P 1+P 2

P2–P1 Q2+Q1
where,
E p = Price elasticity of demand,
Q1 = quantity demanded in the base year,
Q2 = quantity demanded in the following year,
P1 = Price per unit in the base year,
P2 = Price per unit in the following year.

Expected change in Expected Percentage

Quantity demand = Change in Price X Ep
due to a change in price Per Unit
Then:
Projected demand = Current level of 1+ Expected change in quantity
Quantity demand X Demand due to a change in price

Example 1:
Currently the demand for a product is 100,000 units per annum. The price for this product is expected to rise by
10% next year and the price elasticity coefficient is determined to be -0.6. What would be the level of quantity
demanded for this product next year?
Solution:
Estimated % age = Price elasticity X Percentage
change in demand coefficient change in price
= -0.6X↑0.1
= - 0.06 (note that demand and price are inversely related)
The computations reveal that in response to a 10% increase in price level, demand declines by a less than
proportional amount, i.e. by 6%. Thus, demand for next year = 100,000 units X (1 + - 0.06)
= 94,000 units
What would be the level of quantity demanded next year if price declines by 10%. In this regard, the estimated
percentage change in demand would be equal to + 6% (showing an increase), which is obtained as - 0.6 X –0.1.
Thus, quantity demand for the next year = 100,000 units X (1 + 0.06)
 =106,000 units
B. End Use Method (also called Consumption Coefficient Method)
It is suitable for estimating the demand for intermediate products, that is, products used by others as inputs. It
involves the following steps:
1. Identify the possible uses of the product;
2. Define the consumption coefficient of the product for various uses (i.e. consumption per 1 unit of
output);
3. Project the output levels for the consuming industries; and
4. Derive the demand for the product.
It may be difficult to estimate the projected output levels of consuming industries (units). More importantly, the
consumption coefficient may vary from one period to another in the wake of technological changes and
improvements in the methods of manufacturing. Hence, the end use method should be used judiciously.
For instance, given the consumption coefficient of industries A, B, and C vis-à-vis item k and their projected level
of output for year x, the demand for item k can be determined as indicated in the Exhibit below:
Exhibit 5.9: Consumption Coefficient Method
Industry Consumption Coefficient (i.e. Amount Projected Level of Projected Demand for
of Input K Per Unit of Output) Output in Year X Item K in Year X
A 2.0 10,000 20000
B 1.2 15,000 18000
C 0.8 20,000 16000
D 0.5 30,000 15000
Total Demand for Item K in year X …………..………………….………………….……. 69,000
C. Leading Indicator Method
Leading indicators are variables that change ahead of other variables, the lagging variables. Hence, observed
changes in leading indicators may be used to predict the changes in lagging variables. For Example, the change in
the level of urbanization (a leading indicator) may be used to predict the change in the demand for air conditioners
(a lagging variable).
Steps:
1. Identify the appropriate leading indicators.
2. Establish the relationship between the leading indicator(s) and the variable to the forecast.
Merit:
It does not require a forecast of an explanatory variable.
Limitations:
It may be difficult to find appropriate leading indicator(s) and the lead-lag relationship may not be stable over time.
D. Chain Ratio Method
It is a causal method to forecasting sales. Under this approach, the potential sales of a product may be estimated by
applying a series of factors that are likely affecting the demand for that product and hence, used to measure the
level of aggregate demand.
 Example 1:
General Foods of US estimates the potential sales for a new product, a Freeze-Fried instant Coffee (Maxim), in the
following manner:
ƒ Total amount of Coffee sales ……………………………………… 174.5 million units
ƒ Proportion of Coffee used at home ………………………………… 0.835
ƒ Coffee used at home …………………………………………………. 145.7 million units
ƒ Proportion of non-decaffeinated coffee used at home …………….... 0.937
ƒ Non-decaffeinated coffee used at home …………………………….. 136.5 million units
ƒ Proportion of Instant Coffee …………………………………………. 0.400
ƒ Instant non-decaffeinated Coffee used at home …………………….. 54.6 million units
ƒ Estimated long-run market share for Maxim ……………………….... 0.08
ƒ Potential sales of Maxim ……………………………………………… 4.37 million units
Example 2:
Several years ago, a firm planning to manufacture Stainless Steel Blades in India tried to estimate its potential sales
in the following manner:
ƒ Adult male population in the country …………………………………….. 150 million
ƒ Proportion of adult male population using shaving blades ………………. 0.60
ƒ Adult male population using shaving blades ……………………………… 90 million
ƒ Number of times in a year a person, who uses shaving blades, shaves …..... 100
ƒ Total shavings done per year ………………………………………………. 9,000 million
ƒ Proportion of shavings done with Stainless Steel Blades ……………………. 0.40
ƒ Average number of shavings per stainless blade …………………………….. 6
ƒ No. of stainless steel blades used per year (9000 million x 0.4)/6 …………. 600million
ƒ Proportion of the stainless steel market the firm could capture ……………. 0.2
ƒ Potential sales …………………………………………………………………. 120 million units

E. Regression Model: Demand Vs Population

In addition to the above forecasting techniques, the regression model could be used as part of the causal methods,
for instance, if the level of demand is a function of (or causally regress with) population, the latter being forecasted
using the trend technique.
Steps:
 Estimate demand per person or per family (annual basis);
 Identify number of individuals in a single family (average);
 Identify urban versus rural or target population ( if for a segment);
 Estimate expected demand using the forecast of the population in the segment made by the population
function;
 Determine the production function and then forecast expected level of production;
 See if significant gap exists b/n demand and production forecast; and
  See the level of the gap over the trend, learn the implications (potentials) for your project’s marketing and
demand aspect.
Note that the population and production functions are linear, both being developed using the least square technique.
5.5.5. Problems in Demand Forecasting
ƒ Data may not be available (Few observations);
ƒ Available data may not be structured; and may not be suitable for analysis and investigation (lack of
standardization);
ƒ Influence of abnormal factors (war, natural disasters, etc);
ƒ Data needed may be classified one (confidential);
ƒ Uncertainty – the forecasting period is full of uncertainties;
ƒ Environmental changes:
Technological changes,
Shift in government policy,
Developments in the international scene,
Discovery of new sources of raw materials, etc.
ƒ Model constraint:
Difficult to identify a suitable model,
Inability to handle unquantifiable factors,
Unrealistic assumptions,
Excessive data requirement, etc.