Baseline Sales Forecast

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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.

Functional Silo’s
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.

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.

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.

Forecasting Folly

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So, have you all enjoyed the barbecue summer?

It’s difficult to know what was the most bizarre aspect of this summer’s weather forecasting. Perhaps it was the million pound bonus awarded to the Met Office – paid, of course, by all of us long suffering taxpayers – for forecast accuracy; or perhaps it was the feeble justification of the summer forecast: it was a hot summer because “the rain was warm”.

Their reward for all this? Well, Tesco cancelled their Met Office contract and hired their own team of six weather forecasters.

Spin, Spin and Selling News

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If you look at the news headlines today you would be forgiven for thinking that we really were in the biggest recession since the 1930′s.

For example the BBC web site has:

"Retail sales growth almost stalled in February as consumers cut back on spending, official figures show."

The reality, however, is that retail sales are 0.4% UP versus the "boom" period before the crash in 2008.

I am only a simple guy, but to me if sales are at a peak and then they go EVEN HIGHER then that is hardly cause for a wake.

Sure, they are ONLY 0.4% higher BUT they are HIGHER not LOWER.

We know we are in tough economic times.

We know we are having to "mend and make do".

The official stats just keep confirming all the views Schezzer has been writing here since in December.

So Schezzer’s advice to everyone is – watch out for the media (the "repeaters" as some people call them).

Just look at the facts and make your own mind up.

The journo’s have rating points and sales to keep up and this clouds their reporting of the facts.

Unfortunately they do have an influence on people’s decisions and in the current circumstances that influence is unjustified.

Ignore them. Look at the facts. The future will be as we have described it before.


Thought for the Day

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In a previous note Schezzer re-stated an old adage that "the art of forecasting was not to be correct but to be wrong for more sophisticated reasons".

This is amusing (for cynics and for those engaged in the black art) but I think the real motto for practitioners should be "the aim and skill of forecasters everywhere is to always be correct – even if it’s for completely the wrong reasons".

If you work on that basis you will always be popular (people never remember the "why", only the "what") and you may also make some money.

What are the key questions you need to ask to successfully manage your business through the era of austerity?

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Try these:

  • How far will my sales fall (or, will they fall at all)?
  • What expenditures can I cut without undermining the core strength of my business and still making sure we survive the storm?
  • How can I use this event as an opportunity to ready my business to meet the needs of a post-era of austerityary, 21st Century-shaped future, instead of a pre-era of austerityary, 20th Century-shaped past?

Understanding what the future looks like

This era of austerity is different to the previous two or three, and this is not simply as a result of the “credit crunch”.

Three fundamental changes have occurred which mean that economic life in Britain after the era of austerity will be conducted on a very different basis to before.

  • the very obvious change in the attitudes of financiers to loaning money
  • the digital revolution, of which the internet is just part
  • the environmental dimension

A new attitude towards financial risk

This will reduce the underlying rate of growth of borrowing – with a knock-on effect into the rate of growth of house prices – for many years to come. Plus there is the tremendous growth in government debt. This will have to be repaid and, ultimately, will either lead to a period of very high inflation or, if the lid is kept on the money supply, much lower levels of disposable income as the debts are gradually reduced. Either way the net effect will be continued low levels of consumer demand due to low income and high uncertainty.

The Digital Revolution

The era of austerity has accelerated the trend towards on-line shopping and even though it’s not ideal for every industry at the moment, this is changing fast.

The internet has also created a market for re-selling “new and nearly new” products at a fraction of their high street prices and opened-up direct imports from many new channels of cheap supply. Consequently, already in one way or another all sectors are feeling the price pressure from the effects of the new “perfect market” that the internet is taking us towards.

And it doesn’t stop there. The digital revolution has produced a massive increase in the world’s productive capacity alongside a massive decrease in the cost of production. Whilst this initially fuelled a boom in demand it has now created a substantial over-supply situation that had already led to the prices of some goods falling in absolute terms long before the era of austerity started.

The upshot for retailers and manufacturers is that to stay relevant they must “innovate, innovate, innovate” – in products, in customer service and in value. Otherwise margins will be continually eroded as the products they sell, and the way they sell them, become totally commoditised. Branding will be key.

The Environmental Dimension

Companies that harness the perceived new need to “consume responsibly” as we move towards a less ‘fossil-fuel-based’ global economy are already finding themselves rewarded with increasing market shares. This need will grow further in the years ahead and will lead to a new generation of goods and services explicitly designed to support it. Knowing how to harness these alongside traditional needs will be a cornerstone of future success.

Fighting for the Future

To help you plan for the future we can:

  • Tell you where your current sales will fall to so you can plan now, not just react later
  • Use existing industry research, your own data, and our understanding of consumer dynamics to judge how far and how fast sales will recover
  • Use the 5 key dimensions of marketing effectiveness to find out how well your business is tuned to meet and profit from the future and to tell you what changes you need to make to be ready for a new dawn

Every business needs to decide how and where to spend it’s money in order to maximise its success. It’s not just about great products, great prices, great service, or great satisfaction. It is all of these, and more, multiplied together.

The enclosed slides explain the 5 key dimensions every business needs to look at, and quantify their performance on, to know they are making the right moves at the right times to get the biggest bang for every £ they spend.

We can evaluate the strengths and weaknesses of a company in the eyes of its customer’s using these 5 dimensions and experience has shown that this is then totally predictive of future underlying sales performance. Moreover, it highlights which aspects are falling short and which ones, if fixed, would provide the greatest dividends. They are not necessarily the same list.

Will the Future be Bad?

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No, just different.

It will be a bit like doing freefall parachuting for the first time.

The current "credit crunch" has sparked a wave of re-alignments to the new digital world. For a number of years the growth in the use of digital technology and the really far-reaching changes this has had on increasing the underlying productive capacity of the world has largely gone unnoticed by government statistics that are rooted in the manufacturing societies of the 20th century.

In our own industry we have seen the costs of being able to analyse data fall in virtually incomprehensible ways. We can now crunch volumes of data on laptop pc’s in seconds that 20 years ago would have taken several months on a mainframe.

Back in 1996, after Schezzer’s first internet surfing session at an IDV conference in London, Schezzer predicted that the internet would unleash a wave of personal creativity such as the world had never seen before. Today we are seeing this manifest in every aspect of our on-line personal interactions. This blog is just one tiny example.

These changes are fundamental and the post-20th century world in which we currently live has to adjust to these changes.

But why is this happening now, and suddenly, rather than more gradually?

Well the reality is that such realignments always happen "suddenly" and, what appears for many people to be, "unexpectedly".

The truth is, however, that what usually happens is there is a catalyst which first creates a temporary bubble and then usually a specific event (sometimes directly related, sometimes not) which causes people to re-assess the situation.

Such events can be as simple as your local postal service deciding to increase the price of its stamps by twice the rate of inflation which makes you start to think about re-assessing your options for your postal services followed by the need to send a package.

Or they can be as big as the world wide banking sector re-assessing whether it is actually ever likely to get back the money on all those loans it made after seeing a whole housing estate get into difficulties when the local factory closed.

What triggered it this time? Well, as Schezzer predicted late in 2007 and again in the Spring of 2008, the big bubble in demand was caused by the phenomenal investment China was making in itself in the run-up to the Olympics – and this was bound to be punctured almost as soon as the Olympics finished and the money taps were suddenly turned-off.

Unfortunately Schezzer does not have the money to speculate in stocks and commodities but if we had have done we would have been betting on a dramatic fall in the oil price (and all other commodity prices) in the final quarter of this calendar year – when "suddenly" no one can understand where all the demand has gone and, within a short step, drift blindly into "panic mode". It would be comic were it not for the fact that we’re all affected by their collective actions!

Is the situation really as bad as everyone is making out? Well, actually, no.

The dip is being exacerbated by the media hype, which fuels more panic and sells more media. Yet the underlying creativity and "soundness" of the real business world remains.

The big shift is the reluctance of banks to lend, either to us or to each other. We will have to come to terms with this. It is true they were lending unwisely in the first place which helped inflate the bubble.

Back in the early 1980′s when Schezzer first applied for a mortgage we were restricted to a loan of 2.5 times first income plus once times second income, were only allowed to borrow a maximum of 90% of the value of the property (and only then if we signed in blood – the normal restriction was 80%), and had to contend with interest rates that were significantly north of 10% per annum more or less all the time.

As the Assistant Governor of the Bank of England recently acknowledged, getting to the stage where banks were lending people six times joint income and up to 125% of the value of the property was "a little silly", even with interest rates at less than 5%. And Schezzer remembers thinking when being engaged by one of the major insurers to do some marketing research into "lending to the sub-prime market" that they must have found some way to offset the risk.

Our mistake it seems – we should have asked the question! They clearly hadn’t!

So what of the future?

Well, we know that the Government is deeply scared of "deflation" and, in the sense of the spectre of the 1930′s, some wariness is justified. However, the likelihood of deflation is slim in the extreme. Indeed, to Schezzer’s mind, as we live in what used to be called "Rip Off Britain", a bout of heavy price deflation would in fact be well overdue! However, the chances are slim in the extreme.

Any tendency to deflation will be strongly tempered by the reductions in interest rates which will mean that saving money will no longer be a virtue (not that many people in Britain thought it was virtuous in the first place).

Over the next few years inflation will actually begin to spiral out control. Why? Because all the money being pumped into the economy, the low interest rates, and the heavy indebtedness of every part of society will require it. That is the only way we can reduce the real value of the debt burden we are now facing.

How will this come about? Firstly the Tories will win the next election on a promise to reduce taxes where they can and keep the lid on them everywhere else. They will then deliver them but have no money to pay for them. So the only way out is to print money. By hook or by crook this will happen though everyone will deny it even when it is plain to see. Printing money will reduce the value of the pound on world markets and create inflation at home. To some extent this can already be seen even now with the Pound close to parity with the Euro – an anticipation by the markets of what they know has to happen. This reduction in the value of the Pound will cause a massive hike in the cost of imports – including Oil – 12 months from now.

So deflation? You have to be kidding me.

So, my advice is, if you can afford to do so, now is actually a good time to run down your savings or (if you are allowed to do so) run up some more debt. By the time you come to repay it the value of that debt will almost certainly have halved and in the meantime you will have had the benefit of all those goods you purchased.

So enjoy the future, enjoy it’s freedom and it’s creativity, and don’t worry too much about taking on more debt. The current regime is such that they’ll never expect you to be able to pay it back anyway.