Amid the carnage of New Zealand finance company collapses, there are a number of prominent directors who must be wondering what hit them. They have been struck with the sales forecasting hockey stick, a dangerous weapon in the world of commerce.
A bit of marketing commonsense can provide some protection.
Over-optimistic forecasting seems to be plaguing many sectors at the moment, none more so than in the financial realm. In a survey released in Fortune magazine last week, almost a third of sales people interviewed were not sure they’d meet their 2008 targets. Only 21% were ‘completely confident’ they would.
Of course this is partly an indication of the US’ economic malaise, but it is also a symptom of the shakiness of many punts on what sales a company can record.
Several sales forecasting ‘syndromes’ are at the root of this.
First, is the ‘house of cards’ syndrome. This is when the base assumption upon which the whole forecasting edifice is built is questionable. Accountants are very good at modelling and building detail into forecasts, but that is useless if the foundation is shaky.
I’ve seen a number of companies build highly detailed sales forecasts and associated action plans without a clear understanding of their market. The number crunchers could navigate flawlessly back and forth through the spreadsheets, but no one could answer some fundamental questions about how many people might actually be willing to buy the product.
Second, is the ‘hockey stick’ syndrome. This is the classic forecasting situation. Management put the pressure on sales to come up with aggressive targets. The forecast is designed to meet the stretch goal by growing steadily for ten months and then jumps up for the last two, hence the hockey stick in the graph.
Typically there is no real explanation for this jump. It is growth as expected and then a miracle happens to meet the target. Everyone politely ignores the source of this miracle.
Third, the ‘widgets to India’ syndrome. These are forecasts based on the logic that ‘if only I can sell my widget to 5% of their 1.1 billion people’ I’ll be rich. Any forecast based on this logic looks great but doesn’t stand much scrutiny.
A few questions quickly undermine this approach. What segment of this market actually buy widgets, how often, who from, at what price and what other choices do they have. The massive market quickly shrinks.
Lastly, there is the ‘management by spreadsheet’ syndrome, where a forecast is built by simply taking the previous year’s sales and adding a percentage. It is as easy as plugging a formula into a spreadsheet. This is probably the most common approach, but ignores external factors like larger market forces and the actions of competitors.
The common problem with poor forecasting is they take an inside-out, or top-down, approach. Starting from the market and working the way in is a far more powerful way of building a reliable sales forecast.
It all starts with a clear picture of your priority markets, defined as tightly as possible. Then developing a detailed understanding of them – the size, the shape, how often they buy, what prices they’ll pay, who they buy off, what market share competitors have and so on. Once you have that it is an easier task to look at what resources you have and judge what is possible to achieve in terms of sales.
Contrast these two scenarios.
First is a forecast focussed on selling computer software to all hospitals in the USA. You know there are approximately 5700. At a rough estimate you guess 80% use this sort of software and if you sell to 3% (137) of those you’d be doing well.
This number will show nice results on the bottom line, but how realistic is it?
Second, a forecast based on a bit more information. Of the 5700, urban community-owned hospitals easier to access and better suited to your system, so you reduce the target number to 2952.
Added to that is the knowledge that these hospitals replace their systems about once every four years, making the annual available market 738. Three big players control around 70% of the sector leaving you about 221 hospitals to target initially.
Finally you can go inside your company to build a forecast. Estimating what of this available market of 221 hospitals you could potentially target with your existing resources. That is, how many sales people could do how many calls to generate how many proposals with the likelihood of how many sales.
You can have much greater confidence in the target that comes out of the process, and therefore all the numbers that flow from it. What it comes down is the greater level of your market knowledge, the more confidence you can have in your forecasting models.
Having that knowledge, or at least asking the questions, will give you some protection from the damage of being hit by a hockey stick forecast.
Owen Scott is from consulting company Concentrate. He is guilty of hockey stick forecasts in the past.