Of all the forecasts we make regarding future performance, the sales forecast is the most important. Sales represent the measure of value creation according to generally accepted accounting principles (GAAP) and, thus, offer a natural place to begin the forecasting exercise. Of course, forecasts of the expenses, assets, liabilities, and common equity also need to be made. Firms incur expenses and require assets to generate sales. Similarly, firms require vendors, banks, creditors, and common equity owners to finance the assets. However, these items cannot be forecast until estimates of the future sales exist.

We offer two different methods for structuring your forecasts of future sales. The first method centers on forecasting industry sales from macroeconomic variables, what we refer to as top-down forecasting. The second method centers on forecasting sales from a more micro-perspective, what we refer to as bottom-up forecasting. Both approaches begin with an analysis of supply and demand.

Forecasting Changes in Supply and Demand

The first step in forecasting a firm’s sales growth, whether using a top-down or bottom-up approach, is to consider its industry’s supply and demand curves. With the general shape and intersection of these curves in mind, you can begin to map how Porter’s five forces, which explain the firm’s current competitive position, are expected to shift the supply and demand curves in the future and affect the firm’s sales growth.

To think about this more concretely, let’s consider the intersection of a set of hypothetical supply and demand curves for the streaming media content industry in which Netflix competes (Exhibit 8.4). The demand curve plots the number of people who are willing to pay for streaming media content at a given subscription price. The downward-sloping demand curve suggests that the lower the price, the more people are willing to purchase a monthly subscription.

The supply curve plots the number of subscriptions that streaming companies are willing to provide (or supply) to consumers at a given subscription price. The upward-sloping supply curve suggests that higher prices encourage media companies to supply their streaming content to more and more consumers.

As you may remember from your Econ 101 class, P* represents the equilibrium sales price for the good and Q* represents the equilibrium quantity sold. Accordingly, P* multiplied by Q* equals total industry revenue. For the streaming media industry, P* can be interpreted as the average price of a monthly streaming subscription, and Q* can be interpreted as the total number of monthly subscriptions across all streaming media providers.

The exact values of P*, Q*, and the slopes of the demand and supply curves are not very important when thinking about how future market dynamics are expected to affect these curves. Instead, at this early point, we are simply interested in visualizing how current market forces are expected to change in the future. Are the competitive market forces, as described by Porter’s five forces, expected to shift these curves in the future? If so, these shifts will affect the industry’s future sales growth.

Recall our discussion of Porter’s five forces and think about how the streaming media content industry may change in the future. For example, going forward into fiscal 2024 (and beyond), an analyst first might think about whether additional streaming media content providers will enter the industry. That is, the analyst might consider how strong the threat of new entrants or how strong the threat of substitute products is to Netflix. Disney+, Amazon Prime, Apple TV+, and Hulu are examples of companies entering the streaming media content market. To the extent that the analysts believe that the products offered by these firms are comparable to that offered by Netflix, the supply curve for this industry would push out and to the right from S1 to S2 (Exhibit 8.5). If so, notice how expected changes in these forces affect the equilibrium price for streaming content. While the exact drop in subscription price cannot be determined without more information, unequivocally, the price must drop.

On the demand side, an analyst might think about the dynamics facing media content subscribers. Does the analyst think that the number of subscribers is going to increase over the coming years? If so, why? Where will these new subscribers come from? To the extent that the analyst believes aggregate demand for streaming content will increase in the future, the demand curve should shift outward and to the right from D1 to D2 (Exhibit 8.6). If demand does increase, note how the equilibrium subscription price will increase absent an offsetting shift in supply. That is, the intersection of curves S1 and D2 suggests a higher subscription price than the current supply and demand curve intersection suggests (S1 and D1).

At the end of the day, these supply and demand plots are simply tools that help you begin to directionally quantify the effects of the market forces affecting the industry you are examining. You will rarely know the exact equilibrium sales price and quantity sold for a given product. You certainly will not know the exact mathematical formulas that define the shapes of the supply and demand curves. This said, by thinking about Porter’s five forces and how they are expected to shift the supply and demand curves in the future, you can begin to quantify how sales are expected to grow over your forecast period.

For example, shifting away from the streaming media content industry, let’s consider the market for hand sanitizer and other household disinfectants in March 2020. COVID-19 initiated a significant shift in the demand for consumer- and professional-grade disinfectants and sanitizers. Given the change in market dynamics driven by COVID-19, you might expect the demand curve to shift strongly outward at least for a few months (Exhibit 8.7). The supply curve, on the other hand, does not shift as the manufacturing firms that produce the chemicals used in sanitizers cannot immediately shift production from toilet cleaners, for example, to hand sanitizer. Accordingly, if you are forecasting sales growth of firms that sell hand sanitizer, you would expect sales growth to spike strongly in 2020 driven by higher quantities demanded and higher prices.

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