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FORECASTING THE FUTURE FOR PROFIT Markets are complex and multidimensional but it is possible to forecast the future behaviour of a market with a high degree of accuracy. This article looks at how using a unified market model across the organisation allows marketers and their businesses

to understand the complexity of their marketplace and map the interactions between the core structural elements in their market. By applying theories such as Diffusion of Innovation and combining all available insights to create one picture of market

behaviour, businesses can invest in the right markets and target the right segments. As a result the organisation can benefit from increased sales volumes, reduced costs, time efficiencies and better company-wide strategic alignment.

FORECASTING THE FUTURE FOR PROFIT

To be an effective marketer, you need to understand your market.

If you really want to understand your market, you need a model. Overthepast30years, the collectionandavailabilityofmarketdatahasgrownrapidlythanksto technology and, particularly, theinternet.Asaresultthecomplexityoftheinformation available about the markethasgrownsubstantially.However,having‘BigData’andotherinformationaboutthemarketisnotthesameasunderstandingthemarket.Totrulyunderstandamarketand its dynamics, a marketer needs toknowhowallof thestructuralelementsinteract,bothnowandinthefuture.

WHAT IS A MARKET MODEL?A market model is a mathematicalrepresentationofthemarket,constructedfromhistoricdataaboutelementssuchasvendors,pricepoints,geographicregionsand technologies over time.Themodelshows how these different elementsinteractwith eachotherover time.Thisis thenused to forecast future trends intheseelementsandtheconsequencesforthemarket.

Thisinsightintothepresentandthefutureenablescompaniestopositionthemselvesmoreeffectivelyinthemarket,targetandmarkettothesegmentsthataregrowingorhavehighgrowthpotentialandgivethemselvesacompetitiveedge.Italsoprovidesawarenessofhowconsumerchoicesandneedswillchangeovertimeanddifferbyregion.

THE MODELLING PROCESSTogenerateaninitialforecast,statisticaltechniquesareappliedtothecollecteddatatocreateaforecastline.Thiscanbecreatedusingregressionanalysisandtimeseriesanalysis(includingBox-Jenkinsand Holt-Winters methods). However, the results from statisticaltechniques need to be altered to take account of the underlying

NICK MILNER

KAY SHARPINGTON

JONATHAN DAVENPORT

CAMBRIDGE MARKETING REVIEW - ISSUE 8 Q2 2014

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markettrends.Theartofmodellingliesinunderstandingconsumerand market behaviour, applying theories such as Diffusion ofInnovationandconsideringtheimpactofregionalmarketdynamics.Markettheoriessuchaspenetrationcurves,marketlife-cyclesanddisruptionoftechnologyshouldbeconsideredandintegratedintotheforecast.Thiswillensurethattheforecastincorporatesthelonger-termmarkettrends.Thecompany’sregionalmarketintelligenceandon-the-groundknowledgeofthemarketshouldalsobetakenintoaccountintheforecast,toensurethemodelisfullyalignedwiththecompany’sownviewofthemarketdynamicsanddirection.

SOURCE OF ESSENTIAL INSIGHTAmarketmodelcombinesallavailableinsightsdatatoshowafullpictureofmarketbehaviour,whichisessentialformarketingstrategyandplanning.Themarketmodelwillshowthemultipleinteractionsbetweenstructuralelements.Examplesinclude:whichcountriesandregionswillgrow,andwheregrowthwillsloworevendecline;behaviourofdifferentcustomersegments;competitorbehaviour;howtheaveragesellingpricewillalterandhowthiswillbedifferentfordifferingmarkets.

Therearevariousmethodsofcollectingrelevantmarketdata,eachofwhichaddressaspecificaspectofabusiness’futureperformance.However,inisolationnoneofthemgiveafullpictureofthelong-termmarketandshouldnot,therefore,beusedfordevelopingstrategy.

UNDERSTANDING CONSUMERS AND THE MARKETStatistics-basedmodelscanprovideaccurateshort-termforecastsinmaturemarkets.However,researchintechnologymarketsshowsthatpurelystatistical(quantitative)modellingtechniquescannotbereliedupontoprovideaccurateforecastswithoutintroducinganunderstandingofconsumerbehaviourtheories.Adoptionratesofnewtechnologycangrowanddeclinemorequicklythanstatisticaltechniquescanrespond.Whatisrequiredisanunderstandingofthecausesofgrowthatdifferentstagesofamarketlife-cycle.

Internal view: A company may choose its strategy based on internal information, such as recent sales or brand tracking, and therefore set targets such as ‘the previous quarter’s sales +10%’ or ‘launching product x in the next year’. This fails to take account of changes in the market’s growth rate or trends towards certain product types or features.

Historic view: Whilst historic data provides a useful starting point, it is not always a good predictor of the future. Looking at past information does not provide any significant understanding about the future direction of the market; this requires a different methodology.

Qualitative view: Purely qualitative descriptions of market behaviour rarely capture all the relevant information. Even when a description is very thorough, it cannot capture the interactions between variables in the way a market model can. A purely qualitative view will therefore not produce a robust outcome.

“THE ART OF MODELLING LIES IN UNDERSTANDING CONSUMER AND MARKET BEHAVIOUR, APPLyING THEORIES SUCH AS DIFFUSION OF INNOVATION AND CONSIDERING THE IMPACT OF REGIONAL MARKET DyNAMICS.”

“IF THE MARKETING DEPARTMENT PROVIDES ONE MODEL WITH A UNIFIED VIEW ABOUT THE MARKET, THIS PROVIDES THE BASIS FOR A COMPANy TO DERIVE SIGNIFICANT STRATEGIC AND ECONOMIC BENEFITS. THESE BENEFITS ARE AS VALID FOR SMALL COMPANIES AS FOR VERy LARGE COMPANIES.”

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PENETRATION CURVESMostmarketgrowthfollowstheformofapenetrationcurve(alsocalledalogisticfunctioncurveorS-curve).Figure1showshowtheseareconsistentacrossarangeofproducts.Intheearlystagesofpenetrationconsumeradoptionisslow,asmanyareunawareoftheproductorunabletoaffordit.Asmorepeoplebecomeawareofthenewtechnology,theadoptionrateacceleratesascustomerschoosetomaketheirfirstpurchase.Whenthemarketreaches50%penetrationtheadoptionrateslows,astheproductiswidelyknownbuttherearefewerpeopleleftinthemarkettopurchaseforthefirsttime.Asthemarketapproachesfullpenetration(wherethemajorityofthetargetpopulationhasboughttheproduct)therateofgrowthslowsandthemarketismaintainedbyrepeatpurchases.Eachoftheseconsumersegmentshasdifferentattitudesandpreferencesthatthemarketerneedstounderstand.

Inrealitythesesmoothpenetrationcurvesmaybedisruptedbyexternalinfluencesthattheforecastershouldtakeintoaccount.

Forexample,aswecanseeinFigure1,duringstronggrowthintheadoptionof‘autos’therewasaperiodwhenpenetrationdeclined.ThiswasduetotheGreatDepressionfollowedbyWorldWarII,whenmetalandfuelwereneededforthewareffortandthesaleofnewcarswasbanned.

DIFFUSION OF INNOVATIONTheDiffusionofInnovationtheory(Rogers,2003)claimsthatadoptionisdrivenbysocial influencesthataffectvariousconsumers(inB2Cmarkets)andenterprises(inB2Bmarkets)withorwithouttheirexplicitknowledge.

Rogersdescribesfivegroupsofadopterswithadifferentattitudetowardsinnovation.Innovatorsarethefirsttoadoptnewtechnologyandrepresent2.5%ofthetotalmarket.Thisgroupiswillingtoriskfailureofanewproductbecausetheybelieveithas,orwillhave,ahighutility.EarlyAdopterscomprisealargerproportion(13.5%)ofthemarketandunderstandtheutilityofnewtechnologybetter

Figure 1 Consumer product S-curves Source: North, S. (2012).

Figure 2 Diffusion of Innovation (Rogers, 2003).

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becauseoftheexperiencesoftheInnovators.Innovationcontinuestodiffusethroughsubsequentgroupsinthepopulation(theEarlyMajority(34%),theLateMajority(34%),andtheLaggards(16%)witheachgrouptakingitsleadfromthepreviousgroup,andfromthechangessuppliersmaketoproductstomakethemattractivetothetotalpopulation.Figure2illustrateshowprogressthroughthesestagessignificantlyaffectsthemarketgrowthrate.Thegroupshavedifferentcharacteristics,sodifferentmarketingapproachesareneededforeachone.

DiffusionofInnovationhasbeenobservedtofollowlogisticfunction(orpenetration)curvesacrossmanydifferenttechnologiesincludingradio,television,VCR,cable,refrigerators,dishwashers,electrificationofhouseholds,telephones,cordlessphones,cellularphones,personalcomputers,broadbandandtheInternet(MooreandSimon,1999).CombiningmarketvolumedatawithdemographicsandDiffusionofInnovationTheoryproducesagoodmodellingapproachinthetechnologysectors.

TyPES OF MARKETConsumers and themarket behave differently depending on themarket’sstageofmaturity.Broadlyspeaking,therearethreetypes

ofmarket:growingmarkets,maturemarketsanddecliningmarkets(see Figure 3).The correct forecastingmethodologies need to beadopteddependingonthestageofdevelopmentofthemarket.

However,itmustberememberedthatonemarketmightbegrowingandmaturingindifferentregionssimultaneously.Furthermore,notallmarketsleavethegrowthstage–somefailtoreachmaturitystageandmovestraighttodecline(Moore,1990).

MARKET LIFE-CyCLE – DISRUPTION OF TECHNOLOGyThereisacontinuouscycleofinnovationanddisruptionacrossmostmarkets.Thelengthoftimethatamarketremainsinmaturitybeforedecliningdependsonthelevelofinnovationpresentinorpertinentto the market. “Incumbents lose their market leadership (i.e.dominantmarketshare)whenfacedwithdisruptivetechnologicalchange”(Danneels,2004).Thisoccurswhencustomersinamaturemarket stop buying its products and start to adopt the productsfromanew,substitutemarketinstead.Theshiftfromfilmtodigitalcamerasisonesuchexample.

DEFINING THE MARKETAcompany’stargetmarketisasectionofitslarger‘addressable’market,whichconsistsofallthesalesofaproductorservicebyallthesuppliers(i.e.thecompanyanditscompetitors)toallthecustomersinadefinedgeographyoveraspecifictimeperiod.Identifyingtoonarrowanicheinthemarketmeansacompanymaymissthewideropportunitiesavailable,lackawarenessofpotentialthreats,andhaveadistortedviewofthecompany’sactualperformancewithinthemarket.Conversely,definingtoowideamarketwillnotenableacompanytoseethefinerdetailofwhattheirtargetmarketisdoingandwillnotenablemarketerstounderstandtheircustomerssufficiently.Themarketmodelcanthenbeusedtotrackthebehaviourofthetargetmarket.

Figure 3: Market Life Cycle Source: Johnson, G., Scholes, K. and Whittington, R. (2008).

“IN BOTH SUCCESS AND FAILURE IT IS IMPORTANT TO ASK QUESTIONS ABOUT WHy THE MARKET BEHAVED AS IT DID AND FEED THIS BACK INTO THE MODEL.”

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IDENTIFyING THE STRUCTURAL ELEMENTS TO TRACK WITHIN THE MARKETThecoreelementsofanymarketmodelaretheproductorservicevolumes.Tocreateausefulmodel,thevolumescanbegroupedintocustomersegments,pricebands,technologygroups,diseasecategories,geographiesoranystructuralelement.

Themorefactorsthemodelincludes,thelargerthesizeandcomplexity.TakeasimpleexampleofaforecastmodeloftheUKPCmarketwithvolumesdividedintotwopricebands–under£400and£400andover.Ifthetwopricegroupsarethendividedintodesktopsandlaptops,thesizeofthedataisdoubled.IfthedataisthensplitintoEngland,Scotland,WalesandNorthernIrelandthemarketmodelbecomesfourtimeslarger.Furtherelementscanbeaddedtolookatsegments(students,householdsorbusiness),andtheshareof5othercompetitors(PCsuppliers).Ifalloftheabovefactorswereincludedover12quartersthiswouldresultina3,456cellmodel,beforeanysummarisation.

Despitethechallengeofbuildingandmaintainingamodelwithlotsofelements,thebenefitisaforecastthatexactlymatchesamarketer’sneedsoverthetimeframeofinterest.Itisclearthatevenwithasmallnumberofelementsitisnotpossibletoseeallthedatainteractionsandmarketdynamicswithoutamodel.

FORECASTING ACCURACyForecastingaccuracycanbe improvedbyaddingnewdataas itbecomesavailable.Thescientificmethod(hypothesis,experiment,knowledgeandrefinehypothesis)canbeappliedtomarketmodels(forecast, collect future market data, understand, re-forecast).

Regularly updating amodelmeans themarketer can refine theirunderstandingofthemarket.Thismayleadtonewvariablesbeingadded(e.g.movingfromcountrylevelforecasttoindividualsectorforecasts within the country). Measuring forecasting accuracyenablesthemarketertoidentifywhereandhowthemarketdynamicsdifferedfromtheforecast.Inbothsuccessandfailureitisimportanttoaskquestionsaboutwhythemarketbehavedasitdidandfeedthisbackintothemodel.Thiswillincreasetheaccuracyofthenextperiod’s forecast andhelp a company to understand current andfuturecustomerbehaviourbetter.Newhypothesesaboutconsumeradoptionratesandcompetitorbehaviourcanthenbescientificallytested in the marketplace, resulting in greater ongoing marketunderstanding.

BENEFITS OF THE MARKET MODELHavingideasaboutthemarketarenotthesameashavingaformalmarketmodelusedacrossalldepartments.Departmentaltargetsarebasedinpartonideas(whichmaybepersonalorinformal)aboutwhatthemarketisdoingorabouttodo.IftheMarketingdepartmentprovidesonemodelwithaunifiedviewaboutthemarket,thisprovidesthebasisforacompanytoderivesignificantstrategicandeconomicbenefits.Thesebenefitsarevalidforsmallandlargecompanies.

SAVE TIMEMarketdataisneededbydifferentdepartmentsatdifferenttimes.LongtermforecastsmayberequiredforBoardstrategy,InvestorrelationsorR&D,whilstshortertermforecastsareusefulformarketingpromotionsandplanningandtemporarypersonnelrecruitmentcontracts.Ifeachplanorbusinesscaserequiresatrustedindividualmarketforecast,theprocessisslowed.Asinglemodelthereforesavestime.

ALIGN THE WHOLE COMPANyWhenacompanyusesonemodel,itallowsalignmentfromtoptobottom.AmodelcommissionedbytheMarketingdepartmentcanprovidetheconcretedataandinsightand‘OneTruth’(a

Figure 4 The market model has many uses across the company.

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“TO BE AN EFFECTIVE MARKETER, yOU NEED TO UNDERSTAND yOUR MARKET. IF yOU WANT TO UNDERSTAND yOUR MARKET, yOU NEED A MODEL.”

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nick Milner, PhD is the Managing Director at Milner Strategic Marketing Ltd. Nick has had significant strategy and marketing experience across a range of enterprises from small start-ups

to companies listed on the London and Indian Stock Exchanges. He has 25 years of experience in building market models

and forecasting. Nick is a Fellow of the Chartered Institute of Marketing, a Freeman of the Worshipful Company of Marketors, a

Chartered Marketer and a Chartered Psychologist.

kay Sharpington is a Market Analyst at Milner Strategic Marketing Ltd. As part of the Market Analysis team she assists

with building market models, forecasting, customer analysis and competitor analysis. Kay is a Cambridge University graduate with experience in statistical analysis, regression analysis and

econometric modelling.

Jonathan Davenport is a Business Consultant at Milner Strategic Marketing Ltd. He leads the Market Analysis team,

directing the construction of market models, forecasting, customer analysis and competitor analysis. Jonathan is a Chartered

Marketer, with a strong business to business sales and marketing background, developed over a number of years working in the

energy and telecoms sectors.

REFERENCES

Dann Danneels, E. (2004) ‘Disruptive technology reconsidered: A critique and research agenda’ Journal of Product Innovation Management, 21(4), pp 246-258Johnson, G., Scholes, K. and Whittington, R. (2008) ‘Exploring Corporate Strategy’ 8th Edition. Pearson Education Limited

Moore, G. (1990) ‘Crossing the Chasm’ Harper Collins

Moore, S. and Simon, J. (1999) ‘The Greatest Century That Ever Was: 25 Miraculous Trends of the last 100 Years’ The Cato Institute: Policy Analysis, No. 364

North, S. (2012) ‘Speed of Adoption Risk’ http://theinnovationofrisk.com/speed-of-adoption-risk/

Rogers, E. (2003) ‘Diffusion of Innovations’ 5th Edition. New York: Free Press

toforecastmarketbehaviourwithahighdegreeofaccuracyusingamarketmodel.Thisaccurateunderstandingoffutureconsumeradoptionratesandcompetitorperformanceplaysanessentialroleinmarketingandstrategicplanning.Bycombiningallavailableinsightstocreateonepictureofmarketbehaviourthebusinesscaninvestintherightmarketsandtargettherightsegments.Asaresultofthisthecompanycanbenefitfromincreasedsalesvolumes,reducedcosts,timeefficienciesandbettercompany-widestrategicalignment.

company-wideacceptedview)aboutthemarket.ThiscanbeusedbytheBoard,Finance,Marketing,Sales,ProductManagementandDevelopment,Operations,InvestorRelations,andHRdepartments(SeeFigure4).Thismeanseachinteractionbetweendepartmentscanstartwith“whatarewegoingtodo?”insteadof“whatisgoingon?”Themodelallowsdepartmentalfigurestobecheckedagainstthemodelforfeasibility,asthemodelisbasedonthecompany’sownstrategyandfedintobyalldepartments.

FIRST MOVER MARKET ADVANTAGEDiffusionofInnovationtheorydescribesdifferenttypesofconsumerswithdifferentattitudestorisk,productmaturity,productfeatures,priceandotherfactors.Awelldesignedmodelwillhelppredictwhenthemarketisenteringdifferentstagesandhowconsumerbehaviourwillchangeovertime,allowingthecompanytochangemarketing,sales,productanddistributionplansformaximumeconomicbenefit.Firstmoveradvantagecancatchcompetitorsoff-guardandincreasemarketshare.

SHARE THE OUTPUT OF THE MODELTheleadershipteamcanuseextractsfromthemodelintheformofPowerPointpresentationstosharewithteamsofemployees.Detailedreports(sometimescalledDeepDives)onpartofthemodelcanbeproducedtolookatmarketbehaviourinindividualcountriesorsalesterritories,inspecificproductsectorsorofspecificcompetitors.Sharingsomeofthedatawithallemployeesandwiththemarket(viainterviews,articlesandpresentations)isnecessary;thisincreasesclarityofunderstandingandhelpstobuildcompanyreputation.

CONCLUSIONMarketsarecomplexandmultidimensional.Amarketmodelallowsmarketersandtheirbusinessestounderstandthiscomplexityandistheonlywaytomapfullytheinteractionsbetweenthecorestructuralelementsinthemarket.Byselectingappropriatelyfromthetoolsandtechniquesavailableitispossible

“A MARKET MODEL COMBINES ALL AVAILABLE INSIGHTS DATA TO SHOW A FULL PICTURE OF MARKET BEHAVIOUR, WHICH IS ESSENTIAL FOR MARKETING STRATEGy AND PLANNING.”

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