Chapter 3
ESTIMATING DEMAND AND BENEFITS

The starting point for assessing any project must be the identification of demand and benefits. An understanding of these factors is critical because they determine whether the investment will be of value -either because people want to buy the output, in the case of income generating projects, or because the investment contributes to the quality of their lives, in the case of social, environmental and support projects. In particular, the level of demand defines the scale of the investment (and consequently, the volume of production and the operating costs), as well as many other characteristics (e.g. technology, ingredients, seasonality) that will be discussed in more detail later.

The method of estimating demand will vary according to the product or service being offered. The simplest case is that of non-perishable products with widespread demand (such as rice, wheat and maize), but we will also look at determining the demand for perishable, specialized or innovative products, as well as for services. We will also briefly address the costs associated with marketing the good or service produced.

Even projects that do not result in saleable goods or services are still dependent on demand. What is the purpose of constructing a school if there are no children to fill it? Demand may not be expressed in money terms, as it would be for a kilo of cheese, or a shirt, but it definitely must exist. In such cases the challenge is to identify who the users or beneficiaries might be, and what alternatives they have. Sometimes it may even be necessary to estimate the value of the benefits that users receive.

A. Estimating Demand in the Presence of Markets

The market is critical for any investment that is made with the intention of generating income and profits. Where a product or service is to be sold, the amount that people will buy is the measure of demand for that product. No income generating project can sustain itself if it fails to respond to the demands of the market. This means that when producing a product or service and delivering it to the buyer, the project must fulfil the characteristics that the buyers are looking for, in terms of volume, price, packaging, quality, and seasonality of supply, among other factors. If this is done, the product or service will be sold and money generated to continue operations and cover the cost of the investment.

The evaluation of demand (existing or potential) for a proposed product or service must therefore be the first step in determining whether an investment is feasible or not.

The evaluation of demand not only determines the general feasibility of the investment and often the scale of output, it may also have an important impact on the characteristics of the product to be generated, the technology applied; the inputs that can be used (for example, certain types of agrochemicals); and the scheduling of activities. Consequently, any investment proposal that fails to present an explicit examination of the market is, by definition, inadequate.

The tasks involved in evaluating market demand vary, depending on the type of product or service under consideration. Four main categories of goods and services can be identified, each of which has its own features, and requires a different approach to demand evaluation. These categories are:

a) Basic non-perishable products
b) Basic perishable products
c) Innovative or specialized products
d) Services.

Each of these categories is discussed in more detail below:

1. Basic Non-perishable Products

This is the simplest category of products in terms of evaluation. The key characteristics of basic non-perishable products are as follows:

a) They have well established and developed markets with multiple points of sale and purchase. That is to say, it is easy to find both buyers and sellers, and there are standard prices - often publicly available - for the products.

b) They suffer no rapid deterioration in quality after harvest or production, and thus any product not sold today may be sold tomorrow with little or no loss of quality. As a result, storage is relatively easy and prices normally change only slowly from month to month.

c) Price variations within a single market generally reflect widely recognized characteristics of the product (size, colour, variety, quality, etc.) and there is little or no distinction made as to the source of the products. Specific, sometimes legally-established grades often exist that render it easy to see how quality and other characteristics affect prices: for example, no more than 5% broken grains.

Although the concept of "non-perishable" depends on the length of time being considered, this group can include: grains, roots and legumes; many of the traditional export products (coffee, cocoa, sugar, cotton, etc.); and some manufactured products, where there is little difference from one source to another, such as simple tools and agricultural inputs or construction materials (blocks, roofing tiles, etc.). Live animals may also be counted in this category, as there are generally well developed markets for poultry, pigs and cattle, and they are not perishable, in the sense of losing quality from one day to another.

The factors that characterize this category carry three important implications: (i) the market can absorb as much as a small or medium project is capable of producing, and therefore there is no concern about the scale of the investment from a market point of view; (ii) the price of the product is easy to ascertain and will not be influenced by the activities of the project; and (iii) the specifications of the product are generally well established (for example, the percentage of humidity in grain, or the size of a building block).

The only exception to this last rule is if a project decides intentionally to offer a basic product under new specifications (for example a construction block of a new size). However, the product would then no longer fit in this category, but would have to be analysed as an innovative or specialized product (see section below).

Market evaluations for basic non-perishable products are among the simplest to perform. Any concerns about the market would probably focus on price trends over the next few years, as changes in national or even international production, tariff barriers and technologies may result in substantial price shifts in the future. However, forecasts for future prices can frequently be found in publications, bulletins or the data bases of national public institutions or international agencies.

Although the market evaluation is typically very simple, it is still necessary to keep certain key points in mind, especially when dealing with processed foodstuffs;

• The selected price should be justified in the context of medium range tendencies, rather than based on its price during the week in which the market evaluation was carried out.

• Make certain that there is a clear understanding of the characteristics that the market demands of the product; a small difference in size, colour or humidity content can render a product unattractive to potential buyers. Remember: When there is not much difference between products, it doesn’t take a very important fault to lead the buyer to choose a different one.

• If retail outlets, supermarkets or other sellers are going to be used to sell the product, don’t forget the margin they charge for their service. Jewellery is frequently sold at margins of up to 100% or more and even food products can expect margins of 30 to 50%. Identify your distributors as part of the market evaluation if possible, and negotiate margins ahead of time.

2. Basic Perishable Products

Although basic perishable products also face well established markets with many buyers and sellers, they differ from the previous category in one key aspect; the product loses quality rapidly over time. And what a difference that makes to demand evaluation! A market evaluation for perishable products faces problems that are very different from those of non-perishable products. Due to the fact that perishable products are delicate and have a short life once harvested or produced, their markets (although typically widespread and active) are often characterized by variable supplies and strong price fluctuations. Such conditions make it very easy to over- estimate the potential income from the sale of these products.

Among the products found in this category are most fresh vegetables and fruits, fresh seafood, cut flowers and some processed and semi-processed foodstuffs such as bakery goods, fresh juice, milk, etc.

Some of the most important factors that are frequently overlooked in the market evaluation of perishable products are:

a) Losses suffered by the product during harvest, packing, transportation, and marketing can be appreciable. In some cases it is possible to end up selling less than 50% of the volume produced, and losses of 25 to 30% are not uncommon.

b) It is also common to find that the price in one week can be double (or half) the price of the previous week. For perishable products it is possible that the price changes in the course of a single day. These fluctuations can result from changes in demand, but are most frequently the product of changes in supply. If the product is delivered to market when supply is tight prices may be very high. By contrast, delivering to market when the product is abundant may yield only very low prices.

c) Unlike grain or roofing tiles, it is often difficult to keep a perishable product from one day to the next; in the extreme cases, a product that is not sold by the end of the day or week may not only loose all of its value, but also cause additional costs for garbage collection.

It is not surprising, then, that fluctuations in supply and price have a strong influence on the success or failure of a project that generates a perishable product. The extreme variability that affects the prices of perishable products demands exceptional care in estimating the average sale price (see the example presented in the box).

We recommend that when evaluating the market for perishable products, the following factors be given serious consideration:

• Relatively small quantities of perishable products can cause large fluctuations in the prices, especially in small markets. Talk to sellers and other market participants to determine the volumes passing through your selected market and the seasonality of supply. If your product would add significantly to these volumes, consider the feasibility of delivery at periods of short supply, or try and supply to more than one market.

• High prices can result from unexpected short-term conditions; check the price history over several years, if possible. Remember; high prices often attract other investors, resulting in more production and lower prices in the future.

• Be realistic about the physical losses that might be encountered. If the product is delicate, a minimum of 20-30% should be assumed, unless experience shows a way to reduce this figure. Sturdy products might suffer loses of 10-15%.

• Perishable products that are produced year round, such as eggs, milk and bread tend to suffer less price instability because supply is fairly constant. Even so, demand may vary, causing losses at the end of a day if there are too few buyers.

Consider the possibility of negotiating fixed contracts with consumers (agroindustries, restaurants, hospitals, etc.), who offer a guaranteed market, even if you have to accept a lower price.

3. Innovative or Specialized Products

In the two previous sections we considered the differences between perishable products and non-perishable products. But in both cases we dealt with standard products where, from the consumer’s point of view, there is not much difference between the outputs of farm or plant "X" compared with that of farm or plant "Y". However, when dealing with innovative or specialized products, the situation changes drastically.

Innovative products (by definition) have no existing market price, as they are new, but it may be possible to determine likely prices by looking at the price of competing products, or by looking at the price relationship in markets where the product does exist. An exotic fruit, for example, might be unknown in your market, but be sold at a price slightly more than an apple in the capital city. A word of caution here: If the product is known elsewhere, but not sold in your local market(s), ask yourself - why not? You may have hit upon an unexploited market opportunity, but maybe not. It may be instead that the buyers in your area simply do not have the income to afford such a product, or that it does not fit easily with the food and eating habits of the area.

Specialized products might include products with limited sales (where there are not many competitors because of the small size of the market), or they could be products with quite substantial markets, but where - in contrast to basic products - the buyers see important differences in taste, quality, or durability between the competing products. Specialized products could take the form of a jam, a shirt or even a car.

If you manufacture a car, you cannot simply suppose that you can put the same price on it as on a Toyota, and sell as many as you want. In fact it could be that you don’t sell many even at half the price of a Toyota, because, as far as the consumer is concerned, your car and the Toyota are not the same.

This characteristic means that the market evaluation must not only determine the level of demand, the price and the seasonal sensitivity of the product (as in the case of basic products), but also the nature of the product that is in demand. The market defines the product.

A shirt can have long or short sleeves, it can be white, blue or yellow, and it can have four or six buttons. In other words, every shirt is different, and a buyer looking for a formal shirt may not buy a sports shirt.

Products that will likely fall into the category of specialized products include: handicrafts (wooden, cloth or ceramic articles etc.); clothing; many processed foodstuffs (but not all; few consumers may readily distinguish between competing brands of milk); many fruits, vegetables and exotic products; and any innovative product (for example, construction materials, furniture, etc.)

Unless you are lucky enough to find a person with considerable experience in marketing the product in question, it might be necessary to carry out some sort of a market study:

• What is the characteristic of the product that will attract the attention of the consumer? Could it be the price, the quality, the origin, or an element of novelty in its appearance or content? Regardless, every product must offer something for the consumer and the first step in the market evaluation must be to identify that characteristic.

• What kind of person or client will be most likely to buy this product? If it is something out of the ordinary (an exotic fruit or vegetable), perhaps a luxury restaurant would be interested. But in this case it might not be advisable to offer the product in a poor neighbourhood.

• What marketing channel will be used? If the plan is to sell the product through a store, supermarket or other salesperson, you must be sure that they will accept the product and you must determine the profit margin they will charge. If you intend to sell the product directly, in a market or fair, you must identify the most adequate point of sale, based on the target consumer.

Keep in mind:

• In the case of processed products, the packaging is critical. However, even though the market demands attractive packaging, remember that what you are selling is the product, not the package. Therefore, make sure the packaging used is appropriate for the market.

• Generally, processed foodstuffs must comply with legal standards regarding labels (list of ingredients, health permit numbers, etc.). Establish those requisites as part of a market evaluation.

On the previous page two brief stories are presented (see box) that illustrate the importance of appropriate packaging for each product.

4. Services

The evaluation of demand and market characteristics for services raises issues that are quite different from for products. Services are crucially characterized by the transitory nature of their supply. A hotel that only fills 60 of its 100 rooms on one night cannot recuperate its losses on the next night by offering 140 rooms.

Each time a service is offered and there is no buyer, that income is lost forever. The same, however, cannot be said for the costs. Normally, a service company will incur costs whether there are clients or not (although costs may be higher when there is work).

As a result, the critical element in the evaluation of the market for a service consists in establishing the pattern of demand for services over the span of a year (or other period). Although some services (e.g. well digging or transportation) may have a more balanced demand pattern than others (i.e. hotels, agricultural services), it is not sufficient to assume a constant demand for any service, every week or month of the year. In the following example, it can be seen that the demand for the services of a tractor varies greatly according to the agricultural cycle; of an estimated 50 hours per month in January, April, September and October, to 190 in February and March, when preparation of the fields is in full swing.

If you anticipate that the demand is going to vary greatly, there are several available options: One is to charge a variable price for the service, to promote the volume in periods of low demand. Hotels, for example, frequently charge reduced rates for rooms during the "off season compared with "high" season rates. In the example shown, a contractor selling tractor service offers three rates: $10/hour during the slackest period; $15/hour during the harvest; and $20/hr during the soil preparation period, when the demand is strongest. Remember: once the day (or night) has passed, the available service is worth nothing; the opportunity is gone.

5. Marketing Costs

Finally, it is important to bear in mind, as part of the market evaluation, the costs associated with the selling process. As we saw in the tomato example, these costs can have an important impact on an operation.

Among the types of costs to be considered are:

• The cost of packaging the product, including: the container (bag, bottle, jar, box, etc.); the label, and materials for protection during transportation (e.g. cartons for tins, wooden boxes for glass jars);

• Transportation costs from the point of production to the point of sale;

• Costs of distribution and representation (when the product is sold through a distributor or agent);

• The sales margin of the store or other point of sale (when using the final retail price as your base for calculation);

It is useful to remember that some sellers may insist on a policy of "sell or return" or sale on consignment, in which they only pay the producer when the product has actually been sold. This method is very common with handicrafts, such as paintings, jewellery or other works of art. It is also frequently used with new products, when the seller cannot easily calculate the level of demand. It is not a very attractive arrangement for the producer, but it may be the only way to begin the marketing process. Nevertheless, remember: products delivered under this system are not yet sold, and you have to be careful when starting a new round of production, based on these deliveries; they might end up being returned by the store.

B. Estimating Demand in the Absence of a Market

We have seen in the preceding section that the reliable determination of demand levels and prices can be difficult. However, in the absence of markets for the products generated by the investment, the estimation of the demand is even more complex. When a product is sold, you can say that the buyers of that product are its clients or beneficiaries, and the demand corresponds to the number of products sold to them. Of even greater importance is that it may be assumed that the market will give a clear indication of the value of the product, thereby facilitating the estimation of benefits^[2]. But if the product is something like the protection of an ecosystem or a campaign for vaccinating children, then who are the beneficiaries? What is the level of demand? What value can be assigned to the products or services generated?

This problem is encountered by everyone who designs and finances investment projects which generate benefits without direct consumer markets, such as roads, health care centres, reforestation, etc. Many documents on the subject have been written, proposing complex methodologies for resolving these questions.

Of course, when we are dealing with US$10,000 or US$100,000 projects we cannot go into the same detail as for a project aimed at rehabilitating the national healthcare system, with a budget that may well exceed US$100 million. But, even when preparing small projects, it is necessary at the minimum, to determine and estimate the level of demand and benefits expected from the investment.

1. Who are the beneficiaries and how many of them are there?

Before considering the level of demand, it is necessary to first determine who the beneficiaries are. In some cases the answer can be clear; the beneficiaries of a healthcare centre are those who go there to seek medical attention. But it is not necessarily that easy. Should we exclude the people that live in the zone but have no need for the services in a given year? Perhaps they are beneficiaries, simply because they enjoy the availability of the facilities, even though they have not had recent occasion to use them.

Experience has shown that when a rural access road is constructed or improved, one of the greatest resulting impacts is an increase in agricultural production. In addition to facilitating the transportation of products to markets outside the zone, a road also allows for delivering input materials, and for the access of extension personnel to the zone. It may also help children to reach schools and the sick to reach medical care. Thus the beneficiaries are by no means restricted simply to those who drive the trucks and buses on the road; the most important beneficiaries are rather those who live and work nearby.

In some cases, it can be argued that the whole country, and indeed the entire world can be considered as a beneficiary. This is the logic that supports a new type of project, in which rich countries that generate vast quantities of carbon gases (coming from factories and other industrial activities), pay less developed countries to protect and increase their forested areas, where those gases are converted to wood and other organic materials by the trees and other vegetation. In this way the beneficiaries of these projects include people who live in distant continents.

Such great impacts are not to be expected from a small project. However, projects involving infrastructure and conservation of natural resources frequently benefit people living outside the zone. For example, a project for the protection and conservation of mangrove swamps may benefit the shrimp producers (because shrimp larvae live in mangrove swamps), the tourism sector (because mangrove swamps house a plethora of wildlife), and the agricultural producers of the region (because the mangrove swamps act as a buffer zone to protect agricultural zones from storms, erosion etc.).

In order to overcome the problem of direct and indirect beneficiaries, and at the same time, keep the procedures for preparing proposals simple, the RuralInvest methodology requests an estimate of two numbers for projects without direct markets for its products.

First, you should estimate the number of persons that will benefit directly from the project. This includes both employees (e.g. school teachers, nurses in clinics, park rangers, maintenance personnel, etc.), as well as clients and other direct users (patients, school children, vehicle drivers).

Determining this figure for an, as yet, unrealised investment may be difficult. It is often necessary to learn from the experience of others. For example, it may be that you have no idea of the number of patients that might be expected in a new community clinic. However you can find out the prior experience of other clinics of similar size (speaking with staff of Health Ministries or NGOs that deal with these types of activities).

Secondly, you should estimate the number of persons indirectly affected by the investment. In its most simple form, this task consists of calculating the population within a determined distance (e.g. 5 km.) from the site of the investment. This method probably is the most appropriate for clinics, roads, electrification, etc. But remember, there is no logic in saying that the entire population of a Province or Department is an indirect beneficiary of a small healthcare centre in the care of a single nurse. In the case of works such as the protection of a river basin or mountainside, you should attempt to estimate the number of inhabitants that may be affected by the investment, either down river or within the valley, etc.

2. Estimating the Value of the Benefits

Once the population of indirect and direct beneficiaries has been established, the next challenge is to quantify the impact; that is, determine the value of the benefits that will result. It is important to understand that the type and degree of benefit will never be the same for all users. People living near the project site may receive greater benefit than others. By the same token, the example of mangrove swamp protection shows us clearly, that the benefits enjoyed by different types of users - shrimp fishermen, the tourist sector and farmers - can also be very different.

Although there are exceptions, the problems involved in quantifying benefits (e.g. the value of education, or medical treatment that saves the life of a person) are generally far too complex to be attempted in the evaluation of a small project. However, there are cases where it is possible to offer an approximation (see the example in the box presented at the end of this section), especially if there are comparative data from other investments, or some group or agency that has conducted a recent study on the subject.

The difficulties in calculating a precise value for the benefits do not justify forgetting about them. It is very important to provide the financing agency with some description of the nature and magnitude of the expected benefits. In the absence of this analysis, it is highly possible that the agency will choose to finance an alternative proposal in which the applicants give a better explanation of the expected benefits.

3. Other Considerations

Any calculation of benefits assumes that the investment continue to function long enough to generate these benefits. This is where the importance of considering maintenance needs and costs comes in. This subject is discussed in greater detail in Chapters 5.H and 6.A.

It is also important to remember that there may be benefits, simply from the fact that the investment was made, in terms of jobs created in its construction or preparation. If the investment generated a number of jobs during this period, it is important to indicate this benefit clearly in the proposal document.