Before committing to the production of a specific commodity, it is often necessary for the business to establish how much they stand to make in sales. The preferred way of coming to this determination is through the use of demand estimation. The demand estimation process is important since it offers a company the ability to project how much they should produce and how much to charge for it, among other important decisions.
Demand estimation can be thought of as the process through which a firm comes up with an estimate of the amount of demand that exists for a product or service. While marketing can be used to move a commodity, it is prudent and more beneficial to make a product for which demand is already available. Carrying out the demand estimation process and limiting it to the expected levels of demand over a given period of time makes it possible to come up with fairly accurate estimates on the viability of a product.
One major reason why firms undertake a demand estimation is that it helps with pricing. When introducing a product or service to the market, it is imperative to know the price of the commodity. Even when a firm has first-mover advantage, and does not have the benefit of substitutes which can give an idea on how to price the product relative to other commodities, knowing a ballpark figure on the price is important (Federgruen & Hu, 2016). Knowing the demand for the product makes it easier to determine the price since the price is a function of demand and supply. Such knowledge means that a firm can price without asking for a figure that is so high as to alienate customers or too low as to leave money on the table.
Knowing the demand is also an important element in determining the production rates. Rather than put out a large number of goods, wasting a lot of investment in the process, it is better to undertake a demand estimation and approach the production process with foreknowledge (Conlon & Mortimer, 2013). It would make little sense to invest in 1,000,000 units of a product when the market can only support 1,000. Using demand estimation means that a firm is equipped with such knowledge beforehand and is thus able to take advantage of lean production to save capital and resources.
Conlon, C. T., & Mortimer, J. H. (2013). Demand estimation under incomplete product availability. American Economic Journal: Microeconomics, 5(4), 1-30.
Federgruen, A., & Hu, M. (2016). Sequential multiproduct price competition in supply chain networks. Operations Research, 64(1), 135-149.
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