Precision Forecasting Requires a Paradigm Shift

Have you ever had an experience at a meeting that you will never forget? Here’s one of mine.

A few years ago, I was advising a major company in restructuring its supply chain and customer relations. I visited one of the company’s most important suppliers. This supplier was very well run, with a well-regarded sales and operations planning process. In the course of our frank and confidential discussion, a senior VP of the supplier leaned over and said to me, “We always forecast their forecasts.”

The supplier executive was referring to the difficulty of forecasting sales. In fact, my client was quite well run, and had state of the art forecasting and replenishment systems. Nevertheless, the forecasts were often inaccurate, and the supplier simply formed its own judgment about the customer’s upcoming purchases.

Why is forecasting so difficult in so many companies? I thought about this question a few days ago as I prepared for an interview with a writer penning an article on forecasting branch sales and expenses.

Traditional Approaches
The traditional approach to forecasting is to analyze historical trends, and project them into the future, often by product or product line. Of course, this assumes that the future is like the past. It also implicitly assumes that the company does not have the ability to dramatically change sales. In a rapidly changing world, this approach leaves much to be desired.

A second approach is to correlate sales with a broad economic or industry indicator, such as an industry purchasing or inventory index. The difficulty here is that, even if you understand the correlation and relevant time lags, you still have to forecast the indicator.

Here’s a third traditional approach. In many companies, the sales forecast is a compilation of each sales rep’s individual forecast. How does a sales rep forecast sales? For a start, each rep has a sales quota for the upcoming year, and it’s always larger than the previous year’s – even in a declining economy. Think about this: have you ever seen a sales rep forecast sales below his or her quota?

The Underlying Problem
The underlying problem with the first two traditional forecasting approaches is that they are too aggregated and passive to be consistently accurate. In fact, a company’s overall sales is a blend of a set of identifiable revenue streams – difficult to forecast in aggregate, but individually much more amenable to accurate prediction. Importantly, you need a different predictive technique for each major revenue stream. These can be summed into a very precise forecast.

The problem with the third approach, of course, is that not all sales reps meet their quota – often leading management to develop a “secret forecast” using the first two approaches. This is a real problem in a declining economy.

A Precise Approach

The starting point for precision forecasting is to disaggregate a company’s revenues into a set of major revenue streams, each of which has similar characteristics. Here’s an old Byrnes family recipe.

Divide your company’s accounts into core and non-core categories. Core accounts are major accounts where you have a strong relationship and ongoing sales, where you are a dominant supplier. Non-core accounts are lower-volume accounts that either purchase steadily or occasionally. Core products are products that have high aggregate sales volumes, while non-core products are slower movers.

You can display this categorization in a simple 2 x 2 matrix.

Core products in core accounts. This is a critical part of your business. It represents your most important, high volume products in your most important customers. Note that there will be a relatively small number of products and customers in this category.

Here, there are two key elements to a good forecast.

First, it is critical to have ongoing intensive discussions and collaboration with these customers, especially with the customer’s sales and marketing team, so that you develop a deep understanding of the factors that are driving their sales and purchases of your products. Often, you will have as much knowledge as the customer has, and surprisingly often the customer’s replenishment and purchasing team does not have a close relationship with their sales and marketing counterparts, or even a deep understanding of the complexities of their business.

Because there are relatively few key products and customers, this is not an onerous task. Besides, you will develop a very productive set of relationships throughout the customer’s buying center that naturally drive higher sales along with operating cost reductions.

Second, new and lost business reports make all the difference here. Many companies require their sales reps to file reports outlining new and lost accounts. Because sales reps are busy and have many accounts, they often neglect this. By focusing the process on core products in core accounts, and tracking this carefully, you can make the reports pragmatic and effective. This is one of the most critical elements in precision forecasting.

Non-core products in core accounts. Once you have developed a strong understanding of the core products in your core accounts, this knowledge will strongly inform your forecast of their non-core purchases. In the course of your discussions with these major customers, you can find out the big changes they envision, and develop a sense of how these will affect the lower-volume products they purchase.

For example, you might learn that the customer is phasing out a product line, or going after a new set of accounts. Both would have an impact on your sale of non-core products to the customer. Note that this important information would not emerge in an aggregate forecast.

Core products in non-core accounts. This category has two major components.

First, many non-core customers are simply small businesses that do not have a lot of purchase volume, or they may even be larger companies that do not make large purchases in your category. Here, the first two traditional forecasting approaches are adequate.

Second, some non-core customers are really very important, high-potential underpenetrated accounts. This is a critical group because this is where a great sales rep can obtain rapid major sales increases. In fact, in my research and consulting, I’ve found that the top-performing President’s Club winning sales reps in company after company are experts at turning around high-potential underpenetrated accounts.

The key to success in this group is to distill your company’s best practice from your President’s Club winners and teach it to your average performing reps. When your average performers develop account plans to turn around and grow their high-potential underpenetrated accounts, you can simply use the account plans as the basis for forecasting this group. Of course, not all reps will meet their account plans, but with a little experience, you can develop a very good forecast of expected sales of important core products to this group.

Non-core products in non-core accounts. This category is comprised of slow moving products bought both by small businesses, and by high-potential underpenetrated accounts. Here, it makes sense to use the first two traditional forecasting approaches. Because the high-potential underpenetrated accounts are in growth mode, their purchases of non-core products probably will be relatively minor.

Forecasting Paradigm Shift
Precision forecasting involves a paradigm shift in your fundamental approach. Traditional forecasting is largely based on historical, aggregated, passive information.

Precision forecasting, in contrast, involves disaggregating your revenues into critical components, and forecasting each component appropriately. It also involves inserting a major element of control – both intensive discussions and collaboration with major customers, and purposeful penetration of high-potential underpenetrated accounts.

This new paradigm gives you both much better forecasts, and much better account and sales performance. What could be better than controlling your own destiny?

Jonathan Byrnes is a senior lecturer at MIT and author of the recent book, Islands of Profit in a Sea of Red Ink. He is president of Jonathan Byrnes & Co., a consulting company with which he has advised over 50 major companies, medical institutions and industry associations. Contact him at jlbyrnes@mit.edu.