What is forecasting risk? In general, would the degree of forecasting risk be greater for a new product or a cost-cutting proposals? Why?

Forecasting risk is the risk that a poor decision is made because of errors in projected cash flows. The danger is greatest with a new product because the cash flows are probably harder to predict.

Forecasting risk, which is also known as estimation risk, is the possibility that errors in projected cash flows will lead to incorrect decisions. Forecasting risk may be greater for a new product because a new product comes with greater needs of attention to competition. We might ask questions such as the following: Are we certain that our new product is significantly better than that of the competition? Can we truly manufacture at lower cost, or distribute more effectively, or identify undeveloped market niches, or gain control of a market? The company will also have to consider the potential competition. This is because success attracts imitators and competitors.

The way most people think, a new product would carry greater risk than cost reduction measures. A new product may be entirely unproven- thus the correlation of projections to history is largely unknown. Conversely, cost cutting is simply an iterative modification of the current state. In reality, you could have a safe, new product launch with a derivative product (think iPhone 3G vs iPhone 2G), or a highly risky cost-cutting plan (think laying-off half your work force and outsourcing core competencies).

For manufacturing, they need to prepare the raw materials, equipment, manpower to catch the forecast, all this investment will be the risk if the forecast can’t come true; and for the new product, the risk will be higher as it’s not stable in marketing area; and also a accurate forecast can give a clear direction, the expense will be low.