Use your crystal ball
MASTERCLASS:FOR THE AIRLINE industry, forecasting is a core activity. For most Small and Medium Enterprises (SMEs) it comes well down the “to do” agenda. Even worse, there is no guarantee that forecasting is worth the effort.
“The one thing we know about most forecasts is that they are wrong,” says Patrick Gibbons, Professor of strategic management at the UCD Michael Smurfit Graduate Business School. “At a minimum, in making forecasts, firms should think about a range of key parameters, such as market shares, growth rates and so on, as opposed to single-point estimates.
“The amount of resources devoted to forecasting are predicated on how easily reversible the decisions are. Where investment requirements are low, the investment/capital is extremely flexible, or the payback period is very fast, then extensive market forecasting may not be required. Where investment requirements are high, capital is extremely specialised and inflexible, and where the lead-time to bring investment on-stream is very long, then more extensive forecasting is necessary.”
Business advisor Catherine Goodman works extensively with SMEs and says that, even in the current climate, every business needs to have some idea of what is going to happen and how they are going to respond. However, she admits that this is easier said than done.
“At the moment, if you try to talk about strategy to small businesses, they will simply switch off. Their whole focus is on trying to get through to next week,” she says.
Every business needs to have a business plan, built on a detailed understanding of the marketplace in which it operates. This will typically include the size of the total available market, main competitors, recent and anticipated trends and all main costs. Goodman’s advice to smaller businesses is to use different methods to get information, from surfing the internet to talking to customers and suppliers.
“What’s important is making effective use of the information available by gathering it together in a focused way. In tough times, you need to be all ears,” she says.
Forecasting should be an intrinsic part of business planning which starts with identifying what your business is about. This is followed by making sense of your options, making choices and implementing them, reviewing outcomes and making further changes to achieve clearly identified objectives. How often each stage should be revisited depends on how volatile the sector is.
“If it’s really volatile you need to be capturing and reviewing data on a weekly basis. The absolute minimum is quarterly and the majority should be undertaking a monthly review,” says Goodman.
The more often data is collected, the higher its quality, and the easier it is to see emerging trends. “Forecasts are there to inform the decision-making process, to help with what-if analyses, to stimulate thinking about contingency plans. Ultimately the numbers are there to help stimulate thinking and debate among a management team about what the appropriate objectives are and what strategic moves should be made,” says Gibbons.
Ray Bulger, co-founder and chief executive of Irish intellectual property and software company Duolog, knows the difficulties associated with trying to hit targets in rapidly moving markets. He founded the company at the height of the dot.combubble with a primary focus on 3G applications. By the time initial funding was finalised, the target market had disappeared. “We literally arrived at the bus stop to see the bus leaving,” says Bulger.
The company refocused into a related but different IT area which worked for a number of years. But in 2007 the company found its business model to be flawed. “We were second in the world with our IP, but in reality we could have gone under because of our reliance on downstream royalties. We had to exit,” Bulger says. Restructuring absorbed time and money and Bulger says the lesson he learned was the importance of timing.
Bulger draws a clear distinction between market forecasting and revenue forecasting, and between the needs of the various audiences for whom these forecasts are being prepared. He also acknowledges there is a level of uncertainty in any market forecast. He maintains good forecasting requires a combination of intuition, knowledge and luck. Duolog typically uses industry reports to identify overall trends in its market. Spending millions every year on RD, it faces the classic dilemma: how much to spend upgrading existing products to maintain market competitiveness and leadership versus how much to spend developing new, “disruptive” products?
The first scenario is easier to manage as it can be forecast relatively easily through market research with existing customers. However, it does not enhance revenues to any great extent, if at all. The second situation is far more uncertain.
“You are learning everything for the first time but it is important for the business. To stay at the forefront we have to be seen to be revolutionary and disruptive. By nature I am an optimist. Where are we if we don’t have people who dream dreams?”
However, this blue-skies thinking is underpinned by a firm forecasting process at Duolog. Two people, including Bulger himself, are directly responsible for developing forecasts. The company uses salesforce.comto manage its order pipeline and produces weekly and monthly revenue forecasts derived from that. Annual forecasts are prepared as the foundation for budgets, with reassessment and validation every quarter. The company’s long-term forecasts, in the rapidly moving world of technology, are for the next three years.
‘GUT INSTINCT STILL MATTERS’
Michael O’Leary, chief executive, HRM recruitment group, explains how forecasting works in his business
In this volatile environment, how do you forecast changes in demand for your services?
We use an internal forecasting model which brings together continuous monitoring of current workflow and current and future skills predictions from clients and our research team. We achieve 95-97 per cent accuracy with this and build on it for likely future sectoral demand. Ultimately, talking to customers is really the best check and balance to ensure we are getting this right. However, unprecedented events, such as the Euro zone crisis, can drive a truck through even the best-laid plans.
What resources do you invest in market forecasting, and is it all done in-house?
Far more than we used to and it is all done in-house. There is an extreme correlation between the position of Irish exports and volumes in the Irish recruitment market. For our overseas markets, we conduct regular external analysis to understand more about the economic conditions in these regions.
What categories of data does HRM look for and over what period?
We rely on core economic data for likely impact on volumes, and carefully track client demand to predict likely future needs. Right now our analysis is for no more than a rolling 12-month period.
Over what time periods does HRM try to forecast future demand?
We take a very detailed look for a rolling quarter, but work hard to understand the following three quarters. The better we know our customers’ needs, the more accurate our forecasting.
Does HRM use forecasting to drive decisions or does it merely inform the process?
We are a small business that needs to behave like a big business to become one. So the company is driven very tightly against what the data is saying to us. Our structure is a direct reflection of how we see the market. For example, in the past our science and technology team would have been separate entities covering science, engineering, IT and manufacturing recruitment. Those distinctions are not quite so clear anymore.
What are the main challenges in developing effective business forecasting?
It is difficult to capture the right data in the first place, but even more challenging to get managers to rely on it for decision-making. Gut instinct still matters, but there is a thin line between it and stubborn refusal to change. Small businesses, who in theory should have the advantage of greater flexibility, suffer because there is a lack of information systems software available at an affordable price. We had to build our own Customer Intelligence reporting module simply because the product available was either to widely scaled or too expensive to invest in for what we needed.