Commentary & Analysis
Best of Dr. Joe: The Forecasting Game
The Forecasting Game The purpose of research is to give executives objective facts about the marketplace.
By Dr. Joe Webb
Published: April 21, 2008
The Forecasting Game
The purpose of research is to give executives objective facts about the marketplace. Once research gets into the forecasting process, it all too often loses the links to those objective facts and it becomes just another forecast. One of my favorite articles these past few weeks was in Barron’s, the weekly financial newspaper. Their experts picked stocks that were the best to own, and they went up an attractive 8% for the first six months of the year. The stocks they said were best to avoid, however, went up more than 10%.
The real point, though, is that research is not a forecast. Research shows the condition of the marketplace at a particular point in time. The goal of executives is to create change in the marketplace. Executives need to know what the marketplace is, without embellishment, with common sense and accuracy. Too often research is perceived as making a philosophical statement or interpretation. Research shows what is likely based on how participants in a survey responded, and nothing more. Everything after that is interpretation and has nothing to do with the respondents.
But there’s a broader issue. I have seen executives confuse three types of forecasts. First, and actually easiest to produce, is an industry forecast. Second, a company’s own forecast of its operations. And third, a sales forecast. When the second and third are confused, the result could be deadly.
The Industry Forecast
I probably surprised some of you by saying that an industry forecast is easy. That’s not to say that there is not skill required, which there is—and considerable skill and knowledge at that. But judging aggregates is always easier than identifying the pieces that make up that whole and how those pieces interact within an organization. For that reason, it is actually easier to make a ten-year forecast than a one-year forecast. For example, if an industry forecast is off by just six months, that is a 10% change in timing over five years. But in a ten-year period, delays and events that occur sooner begin to balance each other out.
The Company Forecast
Recently, Dick Vinocur commented on long-range planning in his column for the NAPL website. Dick contends that it’s hard for managers to forecast two, three, and five years out. He’s exactly right. And this is an important takeaway point: forecasting an industry is not the same as the forecasting used in the budgetary and planning process. These different types of forecasts should not even be uttered in the same breath. They’re as different as an airplane and an Airedale.
In this case, it’s easier to forecast quarterly and for one year, possibly two years out. The principal reason is that companies have near-perfect knowledge of what they are doing, and their own actions are controllable in the near-term. Out a year or so, competitive actions take their toll, in both directions, affecting the accuracy that one would hope to have. This is why forecasting for major capital investments like new plants or buildings is so difficult, and why lenders look at “track records”—actual performance, and the ability to meet budgets. This practice makes the assumption that short-term abilities imply good long-term forecasting abilities.
Budgetary forecasting does not do much for most businesses. Its primary purpose is to keep managers from making daily incremental decisions in their areas of control without regard to the tasks and needs of other managers. But it should not devolve into arguments over decimal points, when all budgets should really be “round number” exercises. It’s better to work on implementation than to argue over scorekeeping. Too many companies ignore looming problems because “we’re still on budget for this quarter”,ignoring the seeds of problems. Early 1980’s rocker Steve Forbert had a line in a song that always reminded me of this; it went
I’d rather see it when it’s all around me. Hey, what’s the hurry?
Seems a little too late to act, doesn’t it? Rigid adherence to budgets and denial of external factors can be a real obstacle, as some executives are always looking for confirmation of things before they act. By the time you see it, you may have lost customers or market position. The cost of repairing the inaction may be unfortunately high, but that’s often on someone else’s watch.
The Sales Forecast
Where I have found the largest problem in companies with forecasting is their unwillingness to separate good, solid budgeting from sales forecasting. Sales forecasting is really more an exercise in goal-creation than actual budgeting. The purpose of sales efforts is to create change in the marketplace. That is, the purpose of sales is to change the direction of a business from that which it would normally achieve through its natural momentum. This is the main reason why budgets are only good for about a year. These are the transactions that have already been created or are about to be created by today’s efforts and minor incremental decisions. Anything beyond that is speculation.
The sales forecast should naturally be greater than a budgetary forecast. It is dangerous when a budgetary forecast is built upon the hopes and dreams of the sales force, or built on reporting by a sales force that is bullied into putting down “big numbers.” The minute those numbers are not achieved, the first thing companies notice is that they have no cash, and it goes downhill from there. If sales forecasts are achieved, on the other hand, having a surplus of cash is obviously what they call “a high quality problem.”
All of these types of forecasts play an important role in superior management. Confusing them creates so many problems that it would be better not to forecast at all. There are many other kinds of forecasts, of course, and it’s essential to know how they are best used, and how not to use them.
This column originally ran in August of 2006.