Business

Forecasting
What Is Business Forecasting? in the long term, measured in months or
Companies use forecasting to help them years.
develop business strategies. Financial and
operational decisions are made based on Quantitative models include:
economic conditions and how the future • The Indicator Approach: The indicator
looks, albeit uncertain. Past data is collected approach depends on the relationship
and analyzed so that patterns can be found. between certain indicators, for example,
Today, big data and artificial intelligence has GDP and the unemployment rate
transformed business forecasting methods. remaining relatively unchanged over
time. By following the relationships and
Two Approaches then following leading indicators, you
1. Qualitative Models can estimate the performance of the
Qualitative models have typically been lagging indicators by using the leading
successful with short-term predictions, indicator data.
where the scope of the forecast was • Econometric Modeling: This is a more
limited. Qualitative forecasts can be mathematically rigorous version of the
thought of as expert-driven, in that they indicator approach. Instead of assuming
depend on market mavens or the market that relationships stay the same,
to weigh in with an informed consensus. econometric modeling tests the internal
Qualitative models can be useful in consistency of datasets over time and
predicting the short-term success of the significance or strength of the
companies, products, and services, but relationship between datasets.
has limitations due to its reliance on Econometric modeling is applied to
opinion over measurable data. create custom indicators for a more
targeted approach. However,
Qualitative models include: econometric models are more often
• Market Research Polling many people used in academic fields to evaluate
on a specific product or service to economic policies.
predict how many people will buy or • Time Series Methods: Time series use
use it once launched. past data to predict future events. The
• Delphi Method: Asking field experts difference between the time series
for general opinions and then methodologies lies in the fine details, for
compiling them into a forecast. example, giving more recent data more
weight or discounting certain outlier
2. Quantitative Models points. By tracking what happened in the
Quantitative models discount the expert past, the forecaster hopes to get at least
factor and try to remove the human a better than average view of the future.
element from the analysis. These This is the most common type of
approaches are concerned solely with business forecasting because it is
data and avoid the fickleness of the people inexpensive and no better or worse than
underlying the numbers. These other methods.
approaches also try to predict where
variables such as sales, gross domestic
product, housing prices, and so on, will be
The Elements of Forecasting 3. Forecasts cannot integrate their own
1. A problem or data point is chosen. This impact. By having forecasts, accurate or
can be something like "will people buy a inaccurate, the actions of businesses are
high-end coffee maker?" or "what will our influenced by a factor that cannot be
sales be in March next year?" included as a variable. This is a
2. Theoretical variables and an ideal data set conceptual knot. In a worst-case
are chosen. This is where the forecaster scenario, management becomes a slave
identifies the relevant variables that need to historical data and trends rather than
to be considered and decides how to worrying about what the business is
collect the data. doing now.
3. Assumption time. To cut down the time
and data needed to make a forecast, the Special Considerations
forecaster makes some explicit Forecasting can be dangerous. Forecasts
assumptions to simplify the process. become a focus for companies and
4. A model is chosen. The forecaster picks governments mentally limiting their range of
the model that fits the dataset, selected actions by presenting the short to long-term
variables, and assumptions. future as pre-determined. Moreover,
5. Analysis. Using the model, the data is forecasts can easily break down due to
analyzed, and a forecast is made from the random elements that cannot be
analysis. incorporated into a model, or they can be just
6. Verification. The forecast is compared to plain wrong from the start.
what actually happens to identify
problems, tweak some variables, or, in the The negatives aside, business forecasting is
rare case of an accurate forecast, pat here to stay. Appropriately used, forecasting
themselves on the back. allows businesses to plan for their needs,
raising their chances of staying competitive in
Problems with Forecasting the markets. That is one function of business
Business forecasting is vital for businesses forecasting that all investors can appreciate.
because it allows them to plan production,
financing, and other strategies. However, Reference:
there are three problems with relying on https://www.investopedia.com/articles/fina
forecasts: ncial-theory/11/basics-business-
1. The data is always going to be old. forcasting.asp
Historical data is all we must go on, and
there is no guarantee that the conditions
in the past will continue in the future.
2. It is impossible to factor in unique or
unexpected events, or externalities.
Assumptions are dangerous, such as the
assumptions that banks were properly
screening borrowers prior to the
subprime meltdown. Black swan events
have become more common as our
reliance on forecasts has grown.
What Is Forecasting? period occurs where the forecast is
Forecasting is a technique that uses historical compared to the actual results to establish a
data as inputs to make informed estimates more accurate model for forecasting in the
that are predictive in determining the future.
direction of future trends. Businesses utilize
forecasting to determine how to allocate Forecasting Methods
their budgets or plan for anticipated Stock analysts use various forecasting
methods to determine how a stock's price
expenses for an upcoming period of time.
will move in the future. They might look at
This is typically based on the projected
revenue and compare it to economic
demand for the goods and services offered. indicators. Changes to financial or statistical
data are observed to determine the
relationship between multiple variables.
How Forecasting Works These relationships may be based on the
Investors utilize forecasting to determine if passage of time or the occurrence of specific
events affecting a company, such as sales events. For example, a sales forecast may be
expectations, will increase or decrease the based upon a specific period (the passage of
price of shares in that company. Forecasting the next 12 months) or the occurrence of an
also provides an important benchmark for event (the purchase of a competitor’s
firms, which need a long-term perspective of business).
operations.
Qualitative forecasting models are useful in
Stock analysts use forecasting to extrapolate developing forecasts with a limited scope.
how trends, such as GDP or unemployment, These models are highly reliant on expert
will change in the coming quarter or year. The opinions and are most beneficial in the short
further out the forecast, the higher the term. Examples of qualitative forecasting
chance that the estimate will be inaccurate. models include market research, polls, and
Finally, statisticians can utilize forecasting to surveys that apply the Delphi method.
analyze the potential impact of a change in Quantitative methods of forecasting exclude
business operations.. For instance, data may expert opinions and utilize statistical data
be collected regarding the impact of based on quantitative information.
customer satisfaction by changing business Quantitative forecasting models include time
hours or the productivity of employees upon series methods, discounting, analysis of
changing certain work conditions. leading or lagging indicators, and
econometric modeling.
Forecasting addresses a problem or set of
data. Economists make assumptions Reference:
regarding the situation being analyzed that https://www.investopedia.com/terms/f/fore
must be established before the variables of casting.asp
the forecasting are determined. Based on the
items determined, an appropriate data set is
selected and used in the manipulation of
information. The data is analyzed, and the
forecast is determined. Finally, a verification
Business
Cycle
What Is a Business Cycle? What is a Recession?
"Business cycles are a type of fluctuation On the flip side, a business cycle recovery
found in the aggregate economic activity of begins when that recessionary vicious cycle
nations…a cycle consists of expansions reverses and becomes a virtuous cycle, with
occurring at about the same time in many rising output triggering job gains, rising
economic activities, followed by similarly incomes, and increasing sales that feed back
general recessions…this sequence of changes into a further rise in output. The recovery can
is recurrent but not periodic." That persist and result in a sustained economic
description, from the 1946 magnum opus by expansion only if it becomes self-feeding,
Arthur F. Burns and Wesley C. Mitchell, which is ensured by this domino effect
Measuring Business Cycles, remains driving the diffusion of the revival across the
definitive today. economy.

In essence, business cycles are marked by the What is a Recovery?

alternation of the phases of expansion and Of course, the stock market is not the
contraction in aggregate economic activity, economy. Therefore, the business cycle
and the co-movement among economic should not be confused with market cycles,
variables in each phase of the cycle. which are measured using broad stock price
Aggregate economic activity is represented indices.
by not only real (i.e., inflation-adjusted)
GDP—a measure of aggregate output—but Measuring and Dating Business Cycles
also the aggregate measures of industrial The severity of a recession is measured by the
production, employment, income, and sales, three D's: depth, diffusion, and duration. A
which are the key coincident economic recession's depth is determined by the
indicators used for the official determination magnitude of the peak-to-trough decline in
of U.S. business cycle peak and trough dates. the broad measures of output, employment,
income, and sales. Its diffusion is measured
A popular misconception is that a recession is by the extent of its spread across economic
defined simply as two consecutive quarters activities, industries, and geographical
of decline in real GDP. Notably, the 1960–61 regions. Its duration is determined by the
and 2001 recessions did not include two time interval between the peak and the
successive quarterly declines in real GDP.2 trough. In analogous fashion, the strength of
an expansion is determined by how
A recession is actually a specific sort of vicious pronounced, pervasive, and persistent it
cycle, with cascading declines in output, turns out to be. These three P's correspond
employment, income, and sales that feed to the three D's of recession. An expansion
back into a further drop in output, spreading begins at the trough (or bottom) of a business
rapidly from industry to industry and region cycle and continues until the next peak, while
to region. This domino effect is key to the a recession starts at that peak and continues
diffusion of recessionary weakness across the until the following trough.
economy, driving the co-movement among
these coincident economic indicators and the References:
persistence of the recession. https://www.investopedia.com/terms/b/bus
inesscycle.asp
Economic
Cycle
What Is the Economic Cycle? and over- or under-produce as they try to
The economic cycle is the fluctuation of the match ever-changing consumer demands.
economy between periods of expansion
(growth) and contraction (recession). Factors The Keynesian approach argues that changes
such as gross domestic product (GDP), in aggregate demand, spurred by inherent
interest rates, total employment, and instability and volatility in investment
consumer spending, can help to determine demand, is responsible for generating cycles.
the current stage of the economic cycle. When, for whatever reason, business
sentiment turns gloomy and investment
How the Economic Cycle Works slows, a self-fulfilling loop of economic
The four stages of the economic cycle are malaise can result.
also referred to as the business cycle. These
four stages are expansion, peak, contraction, Less spending means less demand, which
and trough. induces businesses to lay off workers and cut
back even further. Unemployed workers
During the expansion phase, the economy mean less consumer spending and the whole
experiences relatively rapid growth, interest economy sours, with no clear solution other
rates tend to be low, production increases, than government intervention and economic
and inflationary pressures build. The peak of stimulus, according to the Keynesians.
a cycle is reached when growth hits its
maximum rate. Peak growth typically creates Austrian economists argue that the
some imbalances in the economy that need manipulation of credit and interest rates by
to be corrected. This correction occurs the central bank creates unsustainable
through a period of contraction when growth distortions in the structure of relationships
slows, employment falls, and prices stagnate. between industries and businesses which are
The trough of the cycle is reached when the corrected during a recession.
economy hits a low point and growth begins
to recover. Whenever the central bank lowers rates
below what the market would naturally
Examples of Economic Cycles determine, investment and business get
The monetarist school of economic thought skewed toward industries and production
ties the economic cycle to the credit cycle. processes that benefit the most from low
Changes in interest rates can reduce or rates. But at the same time, the real saving
induce economic activity by making necessary to finance these investments gets
borrowing by households, businesses, and suppressed by the artificially low rates.
the government more or less expensive. Ultimately, the unsustainable investments go
Adding to the complexity of interpreting bust in a rash of business failures and
business cycles, famed economist and proto- declining asset prices that result in an
monetarist Irving Fisher argued that there no economic downturn.
such thing as equilibrium and therefore,
cycles exist because the economy naturally Special Considerations
shifts across a range of disequilibrium as Governments and major financial institutions
producers constantly over- or under-invest use various means to try to manage the
course and effects of economic cycles. One
tool at the government’s disposal is fiscal Reference:
policy. To attempt to end a recession, the https://www.investopedia.com/terms/e/eco
government can employ expansionary fiscal nomic-cycle.asp
policy, which involves rapid deficit spending.
Conversely, it can try to use contractionary
fiscal policy to stop the economy from
overheating during expansions, by taxing and
running a budget surplus to reduce aggregate
spending.

Central banks try to use monetary policy to

help manage and control the economic cycle.
When the cycle hits the downturn, a central
bank can lower interest rates or implement
expansionary monetary policy to boost
spending and investment. During expansion,
it can employ contractionary monetary policy
by raising interest rates and slowing the flow
of credit into the economy to reduce
inflationary pressures and the need for a
market correction.

During times of expansion, investors seek to

purchase companies in technology, capital
goods, and basic energy. During times of
contraction, investors look to purchase
companies that thrive during recessions such
as utilities, financials, and healthcare.

Businesses that can track the relationship

between their performance and business
cycles over time can plan strategically to
protect themselves from approaching
downturns, and position themselves to take
maximum advantage of economic
expansions. For example, if your business
general follows the same economic cycle as
the rest of the economy, then warning signs
of an impending recession suggest that it is
not a good time for you to expand your
business ad you might instead be better
served by building up a cash reserve against
tough times ahead.
Boom and
Bust Cycle
What Is the Boom and Bust Cycle? are referred to as recessions; if the recession
The boom and bust cycle is a process of is particularly severe, it is called a depression.
economic expansion and contraction that
occurs repeatedly. The boom and bust cycle Additional Factors in Boom and Bust Cycles
is a key characteristic of capitalist economies Plummeting confidence also contributes to
and is sometimes synonymous with the the bust cycle. Investors and consumers get
business cycle. nervous when the stock market corrects or
even a crashes. Investors sell their positions,
During the boom the economy grows, jobs and buy safe-haven investments that
are plentiful and the market brings high traditionally don't lose value, such as bonds,
returns to investors. In the subsequent bust gold, and the U.S. dollar. As companies lay off
the economy shrinks, people lose their jobs workers, consumers lose their jobs and stop
and investors lose money. Boom-bust cycles buying anything but necessities. That
last for varying lengths of time; they also vary exacerbates the a downward economic
in severity. spiral.

Understanding the Boom and Bust Cycle The bust cycle eventually stops on its own.
Since the mid-1940s, the United States has That happens when prices are so low that
experienced several boom and bust cycles. those investors that still have cash start
Why do we have a boom and bust cycle buying again. This can take a long time, and
instead of a long, steady economic growth even lead to a depression. Confidence can be
period? The answer can be found in the way restored more quickly by central bank
central banks handle the money supply. monetary policy and government fiscal
policy.
During a boom, a central bank makes it easier
to obtain credit by lending money at low Government subsidies that make it less
interest rates. Individuals and businesses can expensive to invest may also contribute to
then borrow money easily and cheaply and the boom-bust cycle by encouraging
invest it in, say, technology stocks or houses. companies and individuals to overinvest in
Many people earn high returns on their the subsidized item. For example, the
investments, and the economy grows. mortgage interest tax deduction subsidizes a
home purchase by making the mortgage
The problem is that when credit is too easy to interest less expensive. The subsidy
obtain and interest rates are too low, people encourages more people to buy homes.
will overinvest. This excess investment is
called “malinvestment.” There won’t be Reference:
enough demand for, say, all the homes that https://www.investopedia.com/terms/b/bo
have been built, and the bust cycle will set in. om-and-bust-cycle.asp
Things that have been overinvested in will
decline in value. Investors lose money,
consumers cut spending and companies cut
jobs. Credit becomes more difficult to obtain
as boom-time borrowers become unable to
make their loan payments. The bust periods
Competitive
Pricing
What Is Competitive Pricing? selling an equivalent product at an equivalent
Competitive pricing is the process of price, the business may still attempt to
selecting strategic price points to best take differentiate itself through marketing.
advantage of a product or service based
market relative to competition. This pricing Premium Pricing
method is used more often by businesses For a business to charge an amount above
selling similar products since services can that of the competition, the business must
vary from business to business, while the differentiate the product from those created
attributes of a product remain similar. This by competitors. For example, Apple employs
type of pricing strategy is generally used once the strategy of focusing on the creation of
a price for a product or service has reached a high-end products and ensuring the
level of equilibrium, which occurs when a consumer market sees its products as unique
product has been on the market for a long or innovative. This strategy requires not only
time and there are many substitutes for the improving the product or service itself, but
product. making sure customers are aware of the
differences that justify the premium pricing,
Understanding Competitive Pricing through marketing and branding.
Businesses have three options when setting
the price for a good or service: set it below Loss Leaders
the competition, at the competition, or A loss leader is a good or service being
above the competition. offered at a notable discount, at times
resulting in a loss if the products are sold
Above the competition pricing requires the below cost. The technique looks to increase
business to create an environment that traffic to the business based on the low price
warrants the premium, such as generous of the aforementioned product. Once the
payment terms or extra features. Rather than potential customer enters the store
compete on price, the business must environment, shifting to the role of customer
compete on quality if it hopes to charge a once the decision to purchase the loss leader
premium price. is made, the hope is to attract them to other
store products that generate a profit. Not
A business may set the price below the only can this attract new customers to a
market and potentially take a loss if the store, but it can also help a business move
business believes that the customer will inventory that has become stagnant.
purchase additional products from their
business once the customer is exposed to the At times, loss leader prices cannot be
other offerings. The profitability of the other officially published as a minimum advertised
products can then subsidize the economic price has been set by the manufacturer. The
loss incurred on the below-market priced practice is also forbidden in certain states.
product. This is also known as a loss leader
strategy. Competitive Pricing and Price Matching
Offers
Lastly, a business can choose to charge the When a company is unable to anticipate
same price as its competitors or take the competitor price changes or is not equipped
prevailing market price as given. Despite to make corresponding changes in a timely
fashion, a retailer may offer to match
advertised competitor prices. This allows the
retailer to maintain a competitive price point
for those who become aware of the
competitor's offer without having to officially
change the price within the retailer’s point of
sale system.

For example, in November 2014, Amazon

projected price changes to approximately 80
million items in preparation for the holiday
season. Other retailers, including Walmart
and Best Buy, announced a price-matching
program. This allowed customers of Walmart
or Best Buy to receive a product at the lower
price without risking customers taking their
business to Amazon solely for pricing
reasons.

Reference:
https://www.investopedia.com/terms/c/co
mpetitive-pricing.asp
Penetration
Pricing
What Is Penetration Pricing? once the price begins to rise to or near the
Penetration pricing is a marketing strategy price levels of the competing brand, they may
used by businesses to attract customers to a switch back to the competitor.
new product or service by offering a lower
price during its initial offering. The lower As a result, a major disadvantage to a market
price helps a new product or service penetration pricing strategy is that an
penetrate the market and attract customers increase in sales volume may not lead to an
away from competitors. Market penetration increase in profits if prices must remain low
pricing relies on the strategy of using low to keep the new customers. If the
prices initially to make a wide number of competition also lowers their prices, the
customers aware of a new product. companies might find themselves in a price
war, leading to lower prices and lower profits
The goal of a price penetration strategy is to for an extended period of time.
entice customers to try a new product and
build market share with the hope of keeping Penetration Pricing vs. Skimming
the new customers once prices rise back to With pricing penetration, companies
normal levels. Penetration pricing examples advertise new products at low prices, with
include an online news website offering one modest or nonexistent margins. Conversely,
month free for a subscription-based service a skimming strategy involves companies
or a bank offering a free checking account for marketing products at high prices with
six months. relatively high margins. A skimming strategy
works well for innovative or luxury products
Understanding Penetration Pricing where early adopters have low price
Penetration pricing, similar to loss leader sensitivity and are willing to pay higher
pricing, can be a successful marketing prices. Effectively, producers are skimming
strategy when applied correctly. It can often the market to maximize profits. Over time,
increase both market share and sales prices will reduce to levels comparable to
volume. Additionally, a higher amount of market prices in order to capture the rest of
sales can lead to lower production costs and the market.
quick inventory turnover. However, the key
to a successful campaign is keeping the Small businesses or those in niche markets
newly-acquired customers. can benefit from price skimming when their
products or services are differentiated from
For example, a company might advertise a competitors' and when synonymous with
buy-one-get-one-free (BOGO) campaign to quality and a positive brand image.
attract customers to a store or website. Once
a purchase has been made; ideally, an email Example of Penetration Pricing
or contact list is created to follow-up and Costco and Kroger, two major grocery store
offer additional products or services to the chains, use market penetration pricing for
new customers at a later date. the organic foods they sell. Traditionally, the
margin on groceries is minimal. However, the
However, if the low price is part of an margin on organic foods tends to be higher.
introductory campaign, curiosity may prompt Also, the demand for organic, or natural,
customers to choose the brand initially, but foods is growing significantly faster than the
market for non-organic groceries. As a result,
many grocers offer more extensive selections
of organic foods at premium prices to boost
their profit margins.

However, Kroger and Costco use a

penetration pricing strategy. They are selling
organic foods at lower prices. Effectively,
they are leveraging penetration pricing to
increase their wallet share. While this
strategy may be risky for small grocery stores,
economies of scale permit Kroger and Costco
to employ this strategy. Economies of scale
essentially means that larger companies can
offer lower prices because they buy their
inventory in bulk at a volume discount. The
lower costs allow Kroger and Costco to
maintain their profit margins even while
undercutting the pricing of their competition.

References:
https://www.investopedia.com/terms/p/pen
etration-pricing.asp
 Price
Skimming
What Is Price Skimming? There are enough prospective customers
Price skimming is a product pricing strategy willing to buy the product at a high price.
by which a firm charges the highest initial The high price does not attract competitors.
price that customers will pay and then lowers Lowering the price would have only a minor
it over time. As the demand of the first effect on increasing sales volume and
customers is satisfied and competition enters reducing unit costs.
the market, the firm lowers the price to
attract another, more price-sensitive The high price is interpreted as a sign of high
segment of the population. The skimming quality.
strategy gets its name from "skimming"
successive layers of cream, or customer When a new product enters the market, such
segments, as prices are lowered over time. as a new form of home technology, the price
can affect buyer perception. Often, items
How Price Skimming Works priced towards the higher end suggest
Price skimming is often used when a new quality and exclusivity. This may help attract
type of product enters the market. The goal early adopters who are willing to spend more
is to gather as much revenue as possible for a product and can also provide useful
while consumer demand is high and word-of-mouth marketing campaigns.
competition has not entered the market.
Price Skimming Limits
Once those goals are met, the original Generally, the price skimming model is best
product creator can lower prices to attract used for a short period of time, allowing the
more cost-conscious buyers while remaining early adopter market to become saturated,
competitive toward any lower-cost copycat but not alienating price-conscious buyers
items entering the market. This stage over the long term. Additionally, buyers may
generally occurs when sales volume begins to turn to cheaper competitors if a price
decrease at the highest price the seller is able reduction comes about too late, leading to
to charge, forcing them to lower the price to lost sales and most likely lost revenue.
meet market demand.
Price skimming may also not be as effective
This approach contrasts with the penetration for any competitor follow-up products. Since
pricing model, which focuses on releasing a the initial market of early adopters has been
lower-priced product to grab as much market tapped, other buyers may not purchase a
share as possible. Generally, this technique is competing product at a higher price without
better-suited for lower-cost items, such as significant product improvements over the
basic household supplies, where price may original.
be a driving factor in most customers'
production selections. Reference:
https://www.investopedia.com/terms/p/pric
Firms often use skimming to recover the cost eskimming.asp
of development. Skimming is a useful
strategy in the following contexts: