If everyone's got forecasting tools, why is it such a big concern?
Buzz words can often mean different things to different people, especially the term forecasting. One of the blogs I follow called MBA Mondays recently started a series on Projections, Budgeting and Forecasting that caused me to wonder about an apparent disconnect between the finance organization at many companies and the rest of the business. The majority of larger companies have already implemented what Gartner calls a Corporate Performance Management (CPM) system, yet according to a recent Duke University/CFO Magazine study, the ability to forecast results remains one of the top two internal concerns for CFOs. How can this be? After all, budgeting, planning and forecasting systems are fairly mature at this point. One of the Gartner analysts I recently spoke with suspects it's because they've implemented the system from the CFO's perspective. In other words, they used CPM to automate the financial process around creating a budget. I bet if you asked them about forecasting, they'd say they were already doing this, yet nobody's happy with the results.
In his second post, Scenarios, Fred Wilson suggests it might be better to use the term Projections to describe their key concern. He does a good job explaining the difference between forecasting and projections. Creating projections is essentially a scenario gaming where you begin with several sets of assumptions that you can rank according to likelihood and project their outcome. Fred likes 3: best case, base case and worst case. Most larger companies would love to have between 5 and 7. The notion of tracking likelihood of the base assumptions means you can assign a prediction to the likelihood that a particular scenario will come to fruition. This is a very powerful concept because you can start using this to make some pretty educated decisions about how to handle certain business scenarios looking forward and not backward. Forecasts, on the other hand, are most often extrapolated from historical trends and following them out into the future. This is a subtle, yet important distinction. Relying purely on historical trends to predict future outcomes can be misleading, especially when the unthinkable happens. Just ask the bond traders on Wall Street about the consequences.
These projections are exactly what the business is looking for and is one of two top of mind issues for many CFOs, even though in the CFO magazine studies they are referred to as forecasting. I think herein lies the problem because most CFOs think forecasts when they should be thinking projections. Meanwhile the rest of the business is screaming for these projections and the current capabilities they have just aren't cutting it. In fact, last year's FEI study indicated that many CFOs were attempting to solve the problem by effectively redoing the budget. While faster than the Excel million spreadsheet march, you couldn't even begin to think about the type of Monte Carlo gaming Fred talks about. Imagine running hundreds of scenarios using the budgeting process they've implemented today. Can it be done...sure...you'd just need an army of people to pull it off.
In their book, The Execution Premium, Robert Kaplan and David Norton recommend using TDABC profitability models to create two types of projections. The first is a set of projections (including capacity) as part of the budgeting process to better align the budget with the strategy and the second is a testing process that essentially compares your assumptions periodically to validate that the current set of projections still meet the objectives of the strategy you devised to meet them. This is exactly the same type of strategic war gaming our customer talked about in his presentation. What's interesting about it is that these are things you can do today with software. All you need is a high level model that accepts driver input at the level of your (macro economic) assumptions. While I wouldn't go about using Excel to build the model for this in all but the smallest of companies, best-of-breed profitability modeling and optimization solutions make the process of producing these projections pretty straight forward. Enterprising customers can even begin to mash in the confidence numbers for each scenario. Powerful stuff. In the case of our customer, they created a competitive advantage with this approach and dominated their market.
Current economic conditions have only shown that companies need to do even more of these projections and the rate they need to do them is only accelerating. Gone are the times when you could do them once a year (or less). Most business leaders feel let down by their finance organization. The good news for them is that they have options to relieve them of the anxiety caused by these uncertain times.