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Definition

Chain ratio method

Chain ratio method– estimating market demand by multiplying a base number by a chain of adjusting percentages.   For example, Connect Phone’s product is designed to replace a household’s telephone as well as provide “always-on” Internet access. Thus, only households with broadband Internet access will be able to use the product; finally, not all Internet households will be willing and able to purchase the new product. Connect Phone can estimate U.S. demand using a chain of calculations like the following:

                                  Total number of U.S. households

                                 × The percentage of U.S. households with broadband Internet access

                                 × The percentage of these households willing and able to buy this device

The U.S. Census Bureau estimates that there are approximately 113 million households in the United States. Research also indicates that 50 percent of U.S. households have broadband Internet access. Finally, Connect Phone’s own research indicates that 33.1 percent of households possess the dictionary income needed and are willing to buy a device such as this. Then, the total number of households willing and able to purchase this product is:

 

113 million households × 0.50 × 0.331= 18.7 million households

Households will need only one media phone. Assuming the average retail price across all brands is $750 for this product, the estimate of total market demand is as follows:

18.7 million Households × 1 device per household × $750 =$14 billion

These calculations in the chain ratio method give Connect Phone only a rough estimate of potential demand. However, more detailed chains involving additional segments and other qualifying factors would yield more accurate and refined estimates. Still, these are only estimates of market potential. They rely heavily on assumptions regarding adjusting percentages, average quantity, and average price. Thus, Connect Phone must make certain that its assumptions are reasonable and defendable. As can be seen, the overall market potential in dollar sales can vary widely given the average price used. For this reason, Connect Phone will use unit sales potential to determine its sales estimate for next year. Market potential in terms of units is 18.7 million (18.7 million households ×  1 device per household).

 

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