What is Top-Down Forecasting?

Sales forecasting is one statistical technique that uses top-down analysis. In addition to past sales information, forecasters also use politics, fashion, and even weather to project future sales. Thus, sales forecasts help business owners plan strategies, productions, and distribution for the next few years. Business owners may make educated guesses about future trends, or they may rely on complex mathematical studies for their inventory management.

What is Top-down forecasting? 

For top-down forecasting, all sales data from all locations are combined. For example, all model numbers and color codes are included in the forecast. The next step is to employ statistics to predict sales at particular locations using individual items. The overall sales prediction may need to be broken down into multiple brands, products, or even SKUs, depending on the company's scope. The big picture is taken from this forecasting method, and the components are discussed. An inventory management software like Inventooly can most certainly help get all the data you need for top-down forecasting. 

When performing top-down forecasting, what are the main steps?

Revenue projections provide a good illustration of top-down forecasting. A market size analysis provides the starting point for top-down forecasting. You must first identify the market for your offering and calculate the growth rate by considering any trends happening in the market. In general, falling market size is not a good sign, indicating that consumers are fleeing the market.

Second, you need to figure out what chunk of the market is interested in your product/service. You would now like to capture the same market share as your closest competitors. The TAM SAM SOM model helps perform top-down forecasting.

TAM: Total Available Market

A company's TAM, or Total Available Market, measures the market size to shoot for the moon. Let's take the Coca-Cola example. The cost of all bottles of coke sold by a company (let's call it 'Happy Cola') on a global scale, without considering competition or internal constraints. As a result, the TAM for Happy Cola represents the total demand for coal worldwide. Each value represents all cokes sold globally, expressed in a specific measure—for example, one dollar, one liter, or the total number of consumers.

What is the formula for calculating TAM? You can obtain an accurate estimation of the size of a market in a specific sector by reading industry reports on the internet. 

Occasionally, you must do some calculations yourself, for instance, if the data for a continent is unavailable, and you need to sum or divide more than one figure. You need to multiply the total number of consumers by the average selling price to arrive at the market's value. That is only possible if you know the quantities.

You could also perform keyword research if no industry reports are available for your sector. Check out the Keyword Planner tool in Google Ads to find keywords related to what you offer. There is a breakdown of the number of monthly searches per city, country, continent (whatever you want). It's impossible to estimate market size through keyword research, but it allows you to gauge the interest in certain offerings across different countries.

SAM: Serviceable Available Market

The serviceable available market (SAM) measures a company's total market size, considering the region and type of client. The good public market represents a portion of a company's full market size.

SAM (the US kids running shoe market) accounts for a small portion of TAM (the worldwide shoe market). A company like Happy Shoe, for example, may have TAM equal to all the shoes it sells globally, but its SAM is extremely narrow. The SAM would be the value of all running shoes sold in the US to children if Happy Shoe focuses on children's running shoes. Because SAM is often based on macroeconomic data, performing your market research with industry reports is wise.

SOM: Serviceable Obtainable Market

The SOM stands for the Serviceable Obtainable Market. It represents a company's realistic chances of acquiring SAM within a couple of years. In other words, SOM is a percentage of a market's size based on a comparison to competitors. Your sales target can be boiled down to your market share goal based on your sales target.

Difference between Top-down and Bottom-up forecasting

Initially, a top-down approach begins with a company assessing the market at large. To determine your current market size and sales trends, you choose the current market size for your business. You then analyze your company's strengths and weaknesses in the context of these trends, ideally focusing on increasing your strengths and improving your weaknesses. By estimating how much the market will buy your product, you can develop a marketing strategy.

A bottom-up approach looks at your product or service itself and makes projections based on your information. Which is the number of employees you have, the number of factories you can open and the number of customers you have. As well as reviewing production capacity and departmental expenses, bottom-up forecasts also examine a business' addressable market. This is done to make an accurate projection of future sales.

The top-down approach begins with the entire market and works down, while bottom-up forecasting starts with the individual company and works up. The best way to determine which financial forecasting method is right for you is to understand the pros and cons of both.

Benefits of top-down forecasting

Top-down forecasting is effective when market forces are similar among product items or sales areas. For example, it makes sense to predict the sales of baseballs and baseball bats when the markets move together. Forecasters will often be unable to make meaningful predictions for individual products due to a lack of data. Patterns will be more easily seen, and a more accurate forecast will be provided because of more data. Budget and strategy planning work well with top-down forecasting since it allows for a realistic overall sales picture.

Top-down forecasting has numerous disadvantages.

Sales forecasting from the top down is inaccurate when advertising and markets for individual items differ. The result is that top-down forecasts are rarely effective at the item level compared to bottom-up forecasts. With top-down forecasting, the low and high sales numbers for all products and regions are averaged. As a result, there is no accurate representation of each component individually. As a result, bottom-up forecasts are the most effective when planning manufacturing and distribution.

Conclusion

While top-down and bottom-up are very different in this sense, they are typically used in all types of financial arrangements, such as checks and balances. Top-down investment funds, for instance, might mainly invest based on macro trends. But they will still analyze the fundamentals of their investments before making investment decisions. Contrary to a bottom-up approach, when investors are considering individual assets, they still want to take into account the impacts of systematic effects.

If you need inventory management services for your E-commerce store, reach out to us at Inventooly. Our expert guidance will most certainly give you a better idea of top-down forecasting.