“People don’t realize that we cannot forecast the future. We really can’t forecast all that well, and yet we pretend that we can, but we really can’t. What we can do is have probabilities of what causes what, but that’s as far as we go.”
– Alan Greenspan, Economist and former Chairman of the Federal Reserve
The Perils of Forecasting
Nobody can predict the future. Not even Zoltar.
Humans have tried to do so for thousands of years and have not succeed.
One major impediment to any forecasting endeavour is human nature.
When we dissect history, we apply personal biases, judgments and rationalizations, so that it syncs with our version of reality which originates from our beliefs.
In other words, our minds process past events to fit our personal mental narratives.
Which brings us to this question –
If forecasting is a fool’s errand, why even attempt to do so?
It’s because, as humans we cannot help ourselves from making plans for the future. Our minds want to eliminate the uncertainty of the future and painting a future vision achieves that purpose.
There are several types of forecasting events that happen in the real world, ranging from election forecasts to weather forecasts. For the purpose of this article, we will discuss business forecasts, more specifically – sales and market forecasting.
One common way of predicting the future is to examine the past, try to understand how the present arrived and use that as a basis for extrapolating future.
This approach is becoming outdated in today’s hyper-changing environment, where traditional forecasting approaches, techniques and models are rendered obsolete.
While we cannot make prescient predictions of the future with traditional models, we can mitigate the downsides by following the 10 “FOUNDATION” rules of forecasting.
The 10 Rules of FOUNDATION Forecasting
FOUNDATION forecasting is based on 10 rules, derived from it’s acronym.
- Future – Incorporate Future Oriented Strategic Analysis
- Outside – Integrate the Outside View
- Uncertainty – Alleviate Uncertainty by assigning probabilities
- Nature – Be mindful of the Nature of the forecast
- Dynamic – Frequently update inputs for Dynamic forecasting
- Assumptions – Use Assumptions derived from quantitative and qualitative sources
- Time – Accuracy of the forecast is contingent on the Time period
- Inter-dependencies– Map out possible Interdependent variables
- Objectivity – Maintain high levels of Objectivity
- Navigate – Collaborate with stakeholders to Navigate the forecast trail
Forecasters who remain cognizant of these rules and incorporate the principals behind them in forecasting activities will be able to eliminate several issues that are pervasive in currents sales and market forecasting models. Let’s examine these rules –
1) Future – Incorporate Future Oriented Strategic Analysis
Forecasting is inherently future oriented and supports strategic decision making by articulating potential possibilities. These possibilities are manifested the in the form of upsides and downsides over the status quo. Given the dynamic and rapidly changing business environment, sales and marketing forecasts can no longer rely on traditional time series and regression models. Traditional forecasting models are highly structured, rigid and are more suitable to stable environments, where the past is a leading indicator of the future. Since, the future is getting more complex and chaotic, semi-structured tools and techniques of strategic analysis such as scenario planning, war gaming and simulations need to supplement and inform the assumptions that form the basis of forecasting models. These future oriented tools can play an excellent complementary role to traditional forecast models.
2) Outside – Integrate the Outside View
Sales and market forecasting cannot be done in isolation and needs to incorporate the outside view in the form of competitive analysis and environmental scanning. Competitive analysis can take the form of traditional SWOT (Strength, Weaknesses, Opportunities, Threats) exercise or more in-depth analysis techniques such as Porter’s Five Forces Model, Four Corner’s model or Blue Ocean strategic analysis. Comprehensive competitive analysis provides a solid base of assumptions on competitor moves that impact sales and market forecasts. Similarly, environmental analysis helps the forecaster to gain an insight of current and potential changes in the external environment through the assembling of Social, Technological, Environmental, Economic and Political (STEEP) evidence. This helps the forecaster to discern the fundamental changes that might take place in the market structure.
3) Uncertainty – Alleviate Uncertainty by assigning probabilities
The future will not mirror the pastor or echo the present. It is highly likely that multiple versions of the future could occur contingent on how the multitude of inter-dependencies or variables interact over a given time period. Forecasters should prepare for their eventuality by assigning probabilities to the likelihood of the events or the assumptions that drive the forecasting model. The resulting output should ideally reflect three probabilistic forecast scenarios – low, medium and high. This will enable strategic decision makers to implement specific strategies and tactics for individual probabilistic forecasts.
4) Nature – Be mindful of the Nature of the forecast
Sales and market forecasts can be built from the top-down or the bottom-up. In the top-down approach, the starting point is the total market which is then broken down into its various constituents, which may include segments and individual products. In the bottom-up approach, the forecaster begins with the basic building blocks such as products and then builds segments, categories and markets. Bottom-up forecasting is more suitable for tactical or operational decisions that impact the near term business, while top-down forecasting usually works best for medium to long term strategic decisions.
5) Dynamic – Frequently update inputs for Dynamic forecasting
Traditionally, operational forecasts were updated monthly, while strategic forecasts were updated annually. With the advent of big data and the increase in the volume, types and frequency (real-time) of available inputs, forecasting needs to become more dynamic to keep up with the rapidly changing environment. This will enable strategic decision makers to proactively calibrate tactics and take advantage of possible opportunities and mitigate anticipated risks.
6) Assumptions – Use Assumptions derived from quantitative and qualitative sources
Assumptions are the foundation of any forecasting exercise and should be sourced from quantitative data or qualitative insights derived from market research, scenario planning or war gaming. The tendency of strategic decision makers is to base assumptions on gut feel, past experience or previous history as it is simpler than subjecting their assumptions to analytical rigor. One of the key tasks of the forecaster is to monitor existing assumptions and ensure that they are still relevant in the face of changing market dynamics and modify or replace them with new assumptions.
7) Time – Accuracy of the forecast is contingent on the Time period
Traditionally, operational forecasts such as demand or supply chain forecasting were done on a monthly basis and were focused on the short term (12-24 months). Forecasting done for strategic planning is medium to long term (3-5 years) and done on an annual basis. Near term forecasting can be primarily based on quantitative or statistically driven models or tools and will be more accurate than long term forecasting where probabilistic scenarios derived from scenario planning and war gaming will be needed.
8) Inter-dependencies– Map out possible Interdependent variables
According to chaos theory, the flap of a butterfly’s wings in Brazil could set off a tornado in Texas. Chaos, complexity and turbulence have been recognized as critical external catalysts that necessitated new approaches to strategic decision making, especially after the 2008 global financial crisis. This “Black-Swan” event demonstrated that national and local economies and industries are interconnected and interdependent. On the other hand, we have also seen traditional businesses such as hotels and transportation severely impacted by new age disruptive companies such as Air BnB and Uber. Sales and marketing forecasts should profoundly consider the possible impact of disruptive technologies and “Black-Swan” in their assumptions.
9) Objectivity – Maintain high levels of Objectivity
Forecasters need to maintain the highest level of objectivity and back up assumptions with analytical rigor when challenged by internal stakeholders. They should not allow their own perceptions and judgments to influence the direction of the forecast. If strategic decision makers are providing forecast inputs in the form of assumptions, forecasters should validate these assumptions before incorporating them. Preserving high levels of objectivity will lead to the identification of possible blind-spots that may have a material impact on the forecast.
10) Navigate – Collaborate with stakeholders to Navigate the forecast trail
Business forecasting can get complicated with several company department and functions in disagreement over the forecast assumptions, methodologies and outputs. In multinational companies, this transcends boundaries with global functions disagreeing with the local/country stakeholders. It is common for data sources and assumptions to differ across stakeholder departments leading to several versions of a forecast floating across various levels of the company. In such cases, forecasters need to learn to navigate the forecast pathway and understand the needs and objectives of various entities who have a vested interest in forecasting. With appropriate communication, collaboration and cooperation, many contentious issues can be resolved to the satisfaction of all stakeholders.
Key Take-Away
Forecasts, scenarios and simulations play a key role in key strategic decision making exercises such as long term strategic planning, annual business planning, mergers and acquisitions, business development and licensing. Traditional forecasting tools and techniques are static, linear and need to adapt to the today’s dynamic, turbulent and complex environment. The 10 FOUNDATIONAL rules of forecasting enable companies to enhance their forecasting capabilities and facilitate key strategic decisions.