Why Your Sales Forecasting Process Is Broken and How to Fix It In 2018
At this time of year, there is tremendous optimism for what lies ahead in the year to come, but also a high-level of uncertainty. Most everyone in business is thinking “How will this turn out?” “Will we meet our goals?” “We have a plan but will it deliver the sales we need?” This ambiguity is most acute for the CFO, who often feels it’s a 50/50 shot to make their plan. Accordingly, they create contingencies and reserves to account for variability. Not only is this hedging a barrier to efficient resource allocation, it also creates stress throughout the organization that can hurt productivity and growth.
In our State of Forecasting Report, we found that 90 percent of companies said sales forecasting was important to business success, yet only 13 percent were truly effective at it.
How could something so important remain so broken at the majority of companies? We see three critical problem areas:
In a recent survey, nearly two-thirds of all companies use some form of heuristic to build their plan. The most common form of forecasting is last year plus x %. This is a convenient method because it is simple, incremental, and manageable. It tightens the communication between CEO and CFO, making budgets and earnings easier to plan. Clear metrics enable clear messages to boards, shareholders, and analysts. However, the validity of heuristics has degraded as market complexity has increased. Rules of thumb worked better when competitors were limited and competitive boundaries were less permeable. They worked when the media landscape was smaller and we had far fewer choices than we have today. Yet while the conditions that made heuristics work have changed, the techniques used have not evolved. Budgets and planning are still largely top-down activities driven by the financial side of the business.
Another common challenge in the sales forecasting process is collaboration. Let’s say the first pass of the budget indicates sales need to be up 5% next year. Often the CFO must go through the organization and get buy-in on the plan. Then, Marketing and Sales start to make the case for an adjustment, looking to lower the goal and up the resources. Ultimately, it becomes a reverse engineering problem where the responsibility is distributed across each team’s goals without integrative agreement. Marketing will shoot for things like raising awareness levels, delivering impressions, and driving sentiment changes. Sales teams look at revenue by retailers or what they can deliver through direct to consumer channels. Ultimately each silo has its targets and everyone has high degrees of uncertainty and hopes it works out. In addition to the level of uncertainty around being able to deliver what each discipline can control, there is uncertainty around things like product performance, earned media, word-of-mouth, and competitor actions that aren’t even factors in the planning process.
Accepting something broken.
Finance, marketing, and sales have worked their ways through the budgeting process for years now. One may even say for decades. The process generally delivers the forecasted results because they are tightly constrained by fear of failure. Things need to go up but not too much. Things might have to go down but of course so then do the resources. The routine of the forecast really amounts to a budget that seems achievable. It relies on judgments that are held individually. At no point is there a tool or process that enables detailed collaboration regarding the way all things interact to produce results. It’s a complicated process for complex times. The mismatch is fundamental but most organizations do not have a different paradigm to consider.
So, let’s consider a complicated process for a moment. Building an airplane is complicated. If you follow the instructions you will always get another airplane. Setting a budget is also a complicated process. Companies like Adaptive Planning, Board, and Prophix have all built systems that lead a team through a detailed budget. They all assume some type of linear or cascading relationship between the top goal of last year plus a %. If your base assumptions are engineered correctly, the process is complicated and a standard recipe will get a standard result.
However, we know markets and humans do not behave linearly. They are complex and require a new approach to obtain results by forecasting human behavior. Rather than hold the assumptions about our business performance being reasonably constant, factoring in the complexity of human behavior allows managers to account for the probabilities and ‘what-ifs’.
“What if a competitor launches a product in 2018?”
“What if they lower a price?”
“What if we change our message?”
The goal in complexity is to assign probabilities for uncertainty to ensure that you do not miss opportunities that arise when something emerges. Forecasting in the face of uncertainty does not replace the need for budgeting and planning as it is done now. It requires new processes to be developed that allow the top line revenue estimate of the plan to be examined more fully.
For many, the idea of augmenting the budget process with another task of refining the sales forecast can be, well, exasperating. We have seen companies using the complicated process spend nearly 4 months a year planning and re-planning only to miss their plan by wide margins. Our approach is different; we believe forecasting is a dynamic event. One that needs continuous attention both to decompose what has happened and to anticipate what might happen. Most of our customers update their plan and forecast monthly. As they come to key reporting periods or year-end analysis, they rarely have a significant surge in effort. The key for them is that they are building better sales forecasts that feed and update their budgets. They use Concentric Market® to integrate data and collaborate with internal teams to build a capability that improves accuracy and reduces risk.