Editorials

We encourage our readers to submit relevant articles of interest to be published on this web site. Students, members, and companies are invited to take advantage of this opportunity! Please send your editorial to: Dick Forrest, CPIM dforrest@charter.net

Ira Smolowitz, Ph.D. Professor of Finance and Dean, Bureau of Business Research and Program Development at the American International College, Springfield, MA.

Some of Ira's past articles of interest:

• A View of Education From Both Sides: An Assessment of the American Education System
• Ramifications of the 24/7 Economy
• A Half-'DUH’zen Examples of Poor Organizational Practices
• Work-place Gossip: A Reassessment
• The Disappearance of Courtesy in America: Implications for Business
• Dynamics of Corporate Assumptions
• The Outlook for American Competitiveness
• Consumer Marketing: A Flawed Strategy
• A Healthy Workforce: The Driver of Corporate Financial Performance

The Use and Misuse of Forecasts

By Ira Smolowitz, Ph.D.

Many corporations, including prominent corporations, improperly utilize forecasts. Consider the following:

Forecasts must not be seen by senior managers as a tool for questioning or reassessing performance targets. Nor must they be used to demand changes or improvements. What happened at Procter & Gamble in 1999 was a classic example of mixing forecasts with targets. After abandoning the budgeting process for 1998-1999, the company introduced “stretch” forecasts and asked their managers to set their goals at more ambitious levels than they would have done under the old budgeting system. So managers did just that. They estimated revenues and resource requirements at a higher level; this obviously pleased their bosses, but in the event caused great damage to the company’s reputation with suppliers, customers, and shareholders. The forecasts were far too optimistic, causing costs and inventories to inflate and ending in huge write-offs. The problem was that their forecasts were just that – forecast numbers unrelated to the reality of the business. Managers gave supervisors what they wanted to hear rather than what customers were telling them...1

The mentality/culture of giving someone of importance what he/she wants to hear is common in this country. In my opinion, it is a pervasive condition. It is true on an intra- and inter-organizational basis. CEO’s ‘live or die’ by their ability to meet the earnings/share forecasts of Wall Street analysts. These analyst forecasts are not long-term. How often has the reader heard the cynical comment that long-term to Wall Street ‘is next quarter?’ Even if a corporation’s earning per share (e.p.s.) increases – the stock may still decline because the now (higher) e.p.s. is less than what Wall Street had projected.

Lay-offs, ‘creative accounting’, etc., are often driven by the need to meet forecasted numbers. Forecasts, for example, sales forecasts, often in retrospect, contain errors. These errors may cause - depending on the direction of the forecast error - hiring or layoffs, increased inventory or reduced inventory orders to suppliers, etc. Forecasting errors are of critical importance. As such, not only is the forecast important – equally important is the corporate utilization of the forecast. Page 2 of the above quoted article states the concern most cogently:

If forecasts are used by senior managers to demand immediate action from frontline teams, then trust and confidence will rapidly evaporate. A senior manager at a large French company made this point: “Forecasts and targets must be independent if we want to obtain both relevant action plans and reliable forecasts allowing risks and opportunities to be identified and relevant corrective actions to be taken. They must not be produced for control purposes. There should be no wishful thinking. It is also important to be realistic. Forecasts should reflect the fact that some businesses are cyclical and thus cannot always grow, even if this is politically incorrect.”

A prudent sales force requires inputs from employees at all levels of management. Employee ideas concerning the viability of current and proposed sources of revenue have to come forward in a non-recriminatory setting. How does a CEO do this? Consider the novel, ingenious, method employed by Rite-Solutions, a software company.

Employees buy or sell the stocks and prices change to reflect the sentiment of company’s engineers, computer scientists and project managers – as well as its marketers, accountants, and even the receptionist. 2

Sales forecasts are based on estimates of current and new product viability. The above method, in my opinion, provides a friendly, non-recriminatory, vehicle for generating estimates about product viability. It welcomes and encourages input from all employees. Not only does it enhance the accuracy of a forecast, it serves to build employee morale. It also encourages the promotion of employee ideas.

References
1. Hope, Jeremy “Use a Rolling Forecast to Spot Trends: Working Knowledge" – Harvard Business School – March 13, 2006. (downloaded 3/13/06 from http://hbswk.hbs.edu – p. 2.

2. Taylor, William C. “Here’s an Idea: Let Everyone Have Ideas” The New York Times, March 26, 2006 p. BU3.

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Articles printed with the permission of Dr. Ira Smolowitz, Professor of Finance and Dean, Bureau of Business Research and Program Development at American International College, Springfield, MA.