Baseline Sales Forecast
For most companies, their primary objective is to deliver more sales and profit than the previous year. However they often do this without understanding what the key drivers of performance are and hence the consequences of the decisions they take to deliver growth.
The budgeting and forecasting cycle is consistent across industries and countries. Forecasts are updated on a quarterly basis, budgets for the following year and a corporate plan that looks at a longer time horizon.
Three core issues can be found in most budget processes.
The most common issue is the functional silo – ie that your view is determined by the function you work in. For example, in a retail organisation if you are a store manager you believe you know your store, the local environment, what products will sell better than anybody else – and hence are best placed to judge the sales that are achievable next year.
However, if you are in marketing, you believe that if stores are left to their own devices, they simply repeat what has been done in previous years – it is up to marketing to understand what the customer needs, get the board engaged with new developments and initiatives and then to publicise them – through advertising, promotions, sponsorship etc. It is these activities that drive incremental sales and hence marketing should be accountable for predicting these sales.
Different functional silos within the organisation produce different forecasts from their different viewpoints, which leads to tiresome negotiation and compromise.
What About the Customer?
Because companies are organised in functions the most common approach is to predict performance and hence budget based on these functions. But the only view that is relevant is the customer. This means identifying and then predicting performance based on the things that impact the attitudes and motivations that shape the customer motivation to spend.
The Concept of Relativity
If for most companies the primary objective is to deliver more sales and profit than the previous year, then the key to this is that it is growth relative to the previous year.
You could simply take sales in the previous year and apply an uplift – and hey presto you have a budget. This can work – the risk is that if you haven’t identified the events/activities that delivered the previous years performance then you cannot have confidence that your budget for next year is achievable.
The key thing is that performance is relative and it is the events and activities that drive demand – simply extrapolating sales into the future is too simplistic. It can work when the market and growth is buoyant – but when there is low growth and customers/businesses are tightening their purse strings then it is a high risk approach.
THE ROLE OF THE BASELINE
What is required is an approach that is structured around the relative change in the activities/events that shape customer demand and hence sales.
The role of the baseline is to define the “as is” – by measuring the impact of the events, circumstances and actions (the factors) that have contributed to historic sales performance. This baseline creates a start point understood by all – from this it is then possible to overlay new or extended activities that will be prioritised by companies to deliver the required budgeted sales growth.
The first step in establishing this baseline is identification of the factors that drive sales and there are two kinds of factors.
Factors shaping demand that the company has no direct influence over but influence customer behaviour: for example press coverage about an age of austerity is likely to make people more cautious of what they spend – even if they haven’t had a reduction in income.
Then there are factors that are under a company’s control: the level of press advertising, the product mix, the prices set, stock levels, customer service etc, are all things that a company has direct control over.
For each factor that is either out of or under control, over time there will be variability in outcomes. Prices will change, competitors will do different things, the levels of disposable income and unemployment will change. As a result of this variability it is possible to isolate and hence measure the impact these factors have – and thus be able to quantify the contribution of each to sales.
How do you identify the factors? There is no magic wand but it is always the case that the business knows what the factors are – it is simply that they haven’t thought about the business in this way. It needs an iterative approach to draw this knowledge out and to find the right metric that captures the factor.
At this point the analysis will deliver a robust explanation of the “as is” in terms of the factors that have had the most significant influence in delivering the historic sales performance – expressed in terms of a quantifiable relationship between the factor and sales. This is in the historic baseline.
With the factors and measures defined, one can then establish a forecast baseline. This baseline will reflect predictions of the key variables going forward. For example if inflation is shown to have an impact on sales then the inflation rate forecasts would be built into the projected baseline – reflecting the impact of the projected relative rate of change in inflation on sales.
Changes can be made to overlay onto the baseline to reflect the activities that the company will be doing differently in the future. The addition of these overlays to the baseline is obviously subject to the challenge of functional silo’s – however it will be based on a rational and transparent start point as the impact of price promotions, new store opening hours, new press advertising etc will have been quantified in terms of their historic impact. Thus the decision of where to prioritise investment is more likely to be objective than subjective.
THE RIGHT APPROACH FOR THE CHALLENGES OF TODAY
A combination of circumstances means that a baseline approach is more relevant than it has ever been.
A no growth business environment means it is critical that investment decisions are driven by fact based knowledge and understanding of what is driving performance.
There is now the capability to deliver a baseline that is fit for purpose and is integral to the decision making process.
An approach that can be delivered at a cost that makes it accessible to most companies and not the few blue chips that can afford the big ticket consultancies.
Those companies that both embrace and leverage the insight and knowledge that can be obtained from the rich data at a businesses finger tips are the companies that will continue to thrive in a challenging environment and not fall by the way side in the future.