Forecasting Overview and Steps
Product managers and finance managers partner closely to complete product forecasting. One of the first questions on the income statement is, how many units will be sold? To calculate this number, product managers use forecasting to understand the product's potential. Product managers and other stakeholders must understand the marketplace needs and customer demand to complete an accurate forecast. With a good understanding of the marketplace, a forecast can be used to calculate expected sales and required supply to meet demand. There are four basic forecasting steps to create a product forecast.
First is documenting the total market size as a total addressable market. Let's say there are one million people that could use our product. Next is calculating what portion your product can penetrate or attain. For example, there are two manufacturers in your industry. Each can achieve a 50% market share. Your AMS would be 500,000 customers. Next is collaborating with product sales to determine how many units they believe they can sell to those potential 500,000 customers. After talking with sales, you learn that of the 500,000 customers, 25%, or 125,000, usually purchase one unit each year. The final step is demand planning, which is calculating how many units can be produced. From previous experience, you know that your factory can produce 30,000 units each quarter, 15,000 units more than product sales believe they can sell.
Forecasting Model
With new products, we'll want to understand the total market potential and the market share we can win and then use that information to create a sales forecast. Once we know how much we can sell, we can calculate demand planning to produce enough units. Last, we'll document financial outcomes using financial statements. The process is different when the product is already in the market.
- The first question to consider is the total market. What is the market potential, or has the market changed since your initial product was launched?
- Next, how much market share can we win or what is our current market share today? Market share is the amount of market demand that your product can capture. It's typically a percentage of the total addressable market (TAM).
- Predicting sales forecast can be tricky, but working with the financial manager can help answer how much/how many units the Sales team think they will sell for a new product or did they meet their targets for the initial product?
- After figuring out a sale forecast, next is demand planning. Can we produce enough of a new product to meet demand? If we have an existing product, then did we produce enough?
- Lastly, budget forecasting can commence. What are the planned financial outcomes for a new product vs was the financial outcomes achieved for an existing product?
Consider SMART (specific, measurable, achievable, realistic, timely) when forecasting. It's important to ensure that you are setting goals that are realistic and achievable but also help push growth. Ensure the goals are specific so everyone understands, is on the same page, and is invested in the overall product vision, mission and strategy. Be aggressive but be conservative.
Pricing
There are two common strategies to calculate price; cost-plus pricing and market pricing. Intuitively, cost-plus pricing seeks to understand the product's cost and the desired profit. Market pricing is different in that it aims to consider what customers are willing to pay to calculate the price.
Cost-plus Pricing
Looking at cost-plus pricing, it is known as a bottoms‑up approach to develop pricing. To calculate the price, we look at the total cost of development, including development like IT or manufacturing, marketing expenses, functional department expenses like salaries and tools, and then the cost of goods sold to produce that product. With cost-plus pricing, we'll need to monitor the risk of under or overpricing. Just because it costs you £20 to make a product, it doesn't mean your customer will pay that, plus your desired margin or they may be willing to pay 20 times more than your cost because of the value it creates. The equation for cost-plus pricing is straightforward.
Moving from left to right and top to bottom, price equals the total cost of development divided by the forecasted number of units. Then we take that number and multiply it by our desired margin percentage. The forecasted number of units is a watch-out area for costs plus pricing. The forecast could be based on poor data, so be sure you're confident in your forecast. Cost-plus pricing also ignores changes in demand, so you'll want to monitor that as well. If your demand changes by 50% up or down, you will want to revisit your price to ensure that you're achieving business objectives.
Market Pricing
Market pricing is a top‑down approach; it ignores the cost of creating the product and instead focuses on the total cost of ownership for the customer, including savings made by the customer, revenue gains, and the ongoing cost. The last portion of market pricing is the expected payback period. Is the solution expected to pay for itself in 12 months or 36 months? The market pricing equation is also straightforward.
Moving from left to right, price equals the total cost of ownership considerations multiplied by the payback period. You can use one or all three total cost of ownership inputs.
Pricing Strategy Framework
Below is a framework used by most companies to settle on their final price. The first question that must be answered is, what are the business objectives? Do we desire a high or low market share? Based on that decision, it can help guide the price.
There are four pricing strategies to achieve business objectives. First is penetration pricing. In the graph above, we have a medium-sized market share, and our price is low. We'll penetrate the market by reaching more customers at a lower price. An example is a company selling caps to protect from the sun. Next is value pricing, where the firm has a significant market share and low price.
An example is an organisation that sells toothpaste in a particular country. Next is skimming, where the market share is low, and the price is relatively high. With skimming, the business objective is to capture high profits from fewer customers. Think of electric cars or a first‑class airline ticket. Last is premium pricing, where an organisation has a slightly higher market share than skimming but also a higher price.
An example is a high‑end watch or cell phone. Businesses that pursue premium pricing purposefully do so as part of their brand. They want to attract the best of the best.
