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Seven Keys to Better Forecasting 11-02

Seven Keys to Better Forecasting 11-02

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Forecasting Techniques
Forecasting Techniques

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Seven Keys to Better 
Mark A. Moon, John T. Mentzer, Carlo D. Smith, and Michael S. Garver 
ales forecast-
ing is a man-
agementfunction that compa-nies often fail to
recognize as a key 
contributor to cor-
porate success. Froma top-line perspec-
tive, accurate salesforecasts allow a
company to provide
high levels of customer service. When demandcan be predicted accurately, it can be met in atimely and efficient manner, keeping both chan-
nel partners and final customers satisfied. Accu-
rate forecasts help a company avoid lost sales or
stock-out situations, and prevent customers fromgoing to competitors. At the bottom line, the effect of accurateforecasts can be profound. Raw materials andcomponent parts can be purchased much morecost-effectively when last minute, spot market
purchases can be avoided. Such expenses can be
eliminated by accurately forecasting productionneeds. Similarly, logistical services can be ob-
tained at a much lower cost through long-termcontracts rather than through spot market ar-rangements. However, these contracts can only 
 work when demand can be predicted accurately.
Perhaps most important, accurate forecasting can
have a profound impact on a company's inven-tory levels. In a sense, inventory exists to provide
a buffer for inaccurate forecasts. Thus, the moreaccurate the forecasts, the less inventory that
needs to be carried, with all the well-understood
cost savings that brings. The ultimate effects of sales forecasting ex-cellence can be dramatic. Mentzer and Schroeter(1993) describe how Brake Parts, Inc., a manufac-turer of automotive aftermarket parts, improved
bottom line by $6 million per month after
Excellence in sales
forecasting can boost 
a firm 's financial health
and gratify customersand employees alike,
launching a company-wide effort to improvesales forecasting effectiveness. Nevertheless, firmsoften fail to recognize the importance of this
management function. Our objective here
is to take what we've learned about sales fore-
casting from working with hundreds of compa-
nies, and summarize that learning into seven key 
focus points (summarized in
Figure 1)
that will
help any company improve its forecasting perfor-mance. Although no management function can
be reduced to seven keys, or 70 keys for thatmatter, our hope is that the ideas presented here will inspire senior management to look closely attheir own sales forecasting practices and recog-
nize opportunities for improvement.
Key #1: Understand What Forecasting Is,
and What It Is Not
 The first and perhaps most important key to bet-ter forecasting is a complete understanding of 
 what it actually is and-of equal importance-
 what it is not. Sales forecasting is a management
process, not a computer program. This distinctionis important because it affects so many areasacross an organization. Regardless of whether a
company sells goods or services, it must have aclear picture of how many of those goods orservices it can sell, in both the short and long terms. That way, it can plan to have an adequate
supply to meet customer demand.Forecasting is critical to a company's produc-tion or operations department. Adequate materi-
must be obtained at the lowest possible price;adequate production facilities must be provided
at the lowest possible cost; adequate labor mustbe hired and trained at the lowest possible cost;and adequate logistics services must be used to
avoid bottlenecks in moving products from pro-ducers to consumers. None of these fundamentalbusiness functions can be performed effectively  without accurate sales forecasts.
Business Horizons /September-October 1998
Many companies consider the most important
decisions about forecasting to revolve around the
selection or development of computer softwarefor preparing the forecasts. They have adopted
the overly simplistic belief that "If we've got goodsoftware, we'll have good forecasting." Our re-
search team, however, has observed numerousinstances of sophisticated computer systems put
into place, costing enormous amounts of timeand money, that have failed to deliver accurate
forecasts. This is because system implementation
has not been accompanied by effective manage-
ment to monitor and control the forecasting pro-
One company we worked with has an excel-
lent computer system with impressive capabilitiesof performing sophisticated statistical modeling of seasonality and other trends. However, the sales-
people, who are the originators of the forecast,
use none of these tools because they do not un-
Figure 1The Seven Keys to Better Forecasting
Seven Keys to Better Forecasting
Issues and Symptoms 
Ac ions 
Understand what 
 forecasting is 
and is not.
Computer system as focus,rather than management
processes and controls
Blurring of the distinction
between forecasts, plans, and
Establish forecasting group
mplement management
control systems before
selecting forecasting software
Derive plans from forecasts
Distinguish between forecasts
and goals
An environment in whichforecasting is acknowledged
as a critical business function
Accuracy emphasized andgame-playing minimized
Forecast demand, plan supply.
Shipment history as the basis
for forecasting demand
"Too accurate" forecasts
Identify sources of information
Build systems to capture key demand data
mproved capital planning
and customer service
Duplication of forecastingeffort
Mistrust of the "official"
Little understanding of the
mpact throughout the firm
Establish cross-functional
approach to forecasting
Establish independent forecastgroup that sponsors cross-functional collaboration
All relevant information used
to generate forecasts
Forecasts trusted by users
Islands of analysis eliminated
More accurate and relevant
Eliminate islands 
of analysis.
Mistrust and inadequate infor-
mation leading different users
to create their own forecasts
Build a single "forecasting
Provide training for both users
and developers of forecasts
More accurate, relevant, and
credible forecasts
Optimized investments in
Use tools wisely.
Relying solely on qualitative
or quantitative methods
Cost/benefit of additional
Integrate quantitative andqualitative methods
Identify sources of improved
accuracy and increased error
Provide instruction
Process improvement in
efficiency and effectiveness
Make it important.
No accountability for poor
Developers not understanding
how forecasts are used
 Training developers to under-
stand implications of poor
Include forecast performancein individual performance
plans and reward systems
Developers taking forecasts
A striving for accuracy 
More accuracy and credibility
Measure, measure,
Not knowing if the firm is
getting better
Accuracy not measured at
relevant levels of aggregation
Inability to isolate sources of forecast error
Establish multidimensional
Incorporate multilevel
Measure accuracy whenever
and wherever forecasts are
Forecast performance can beincluded in individual perfor-
mance plans
Sources of errors can be
isolated and targeted for
Greater confidence in forecast
The ideas presented in this article are drawn from a program of rethat has spanned more than 15 years.
began in 1982 withsurvey of 157 companies that explored the techniques they usedd
years later, under the sponsorship
of AT&T
the survey was replicated and expanded in
to explore not onlytechniques but also the systems and management processes used by
conducted between 1994 and 1996, was sponsoby a consortium of companies consisting
of AT&T
Network -Systems,
Andersen, Consulting, Anheuser-Busch, and Pillsbury. It took the form' of a
benchmarking study that consisted
in-depth analysis of 20 companies:'.
Anheuser-Busch, Becton-Dickinson, Coca-Cola, Colgate-Palmolive,
eral Express, Kimberly Clark, Lykes Pasco, Nabisco, JCPenney,
ProSource, Reckitt Colman, Red Lobster,
Tobacco, Sandoz, ScheringPlough, Sysco, Tropicana, Warner Lambert, and Westwood Squibb.
Finally,' -
has been conducted since 1996 and consists of 
of fore-
cast audits: The forecasting practices of seven companies-Allied Signal,
Agricultural Products Canada, Eastman Chemical, Hershey
USA, Lucent Technologies, Michelin North America, and Union Pacific ..
Railroad have been studied so
in this phase and compared to those
of the 20 benchmarked
The references to this research arelisted at the end of this article.ormal studies, the learning
nted by
than 20 years of g with a large number of major
R g
and processes.firsthand observation of whatsting in companies, large;
d services and that are "
or retailers.
In additign io
presented here i
experience to c
corporation.Our ideas
and s
derstand them and have no confidence
in the
numbers generated. As a result, their forecasts arebased solely on qualitative factors and are oftenvery inaccurate. A similar case is a technology-based company that has created another highlysophisticated forecasting tool, yet the salespeoplecontinue to underforecast significantly becausetheir forecasts have a direct effect on their sales
quotas. Both of these examples show how some
companies focus on forecasting systems ratherthan forecasting
On the other hand, some companies have
been more successful in their efforts by
ing the importance of forecasting as a manage-ment process. Some have organized independent
groups or departments that are responsible for
the entire forecasting process, both short- andlong-term. One large chemical company
formed a forecasting group not associated witheither marketing or production. It has ownershipand accountability for all aspects of forecastingmanagement, with responsibility not only for thesystems used to forecast but also for the numbersthemselves. The group accomplishes its missionin several ways: providing training in the meth-ods and processes throughout the company; de-signing compensation systems that reward fore-
cast accuracy; and facilitating communication
among sales, marketing, finance, and productiondepartments, thereby improving overall forecast-ing effectiveness. Recognizing the importance of forecasting, this firm has put an organization in
place to manage the process, not just to choose
and manage a system.Another way in which companies confusewhat forecasts are and what they are not is byfailing to understand the relationship betweenforecasting, planning, and goal setting. A salesforecast should be viewed as an estimate of whatfuture sales might be, given certain environmen-
tal conditions. A sales plan should be seen as a
management decision or commitment to what thecompany will do during the planning period. A
sales goal should be a target that everyone in the
organization strives to attain and exceed.Each of these numbers serves a differentpurpose. The primary purpose of the sales fore-cast is to help management formulate its sales
plan and other related business plans-its com-
mitment to future activity. The sales plan's pur-pose is to drive numerous tactical and strategicmanagement decisions (raw material purchases,human resource planning, logistics planning, and
so on),
realistically factoring in the constraints of 
the firm's resources, procedures, and systems.The sales goal is primarily designed to providemotivation for people throughout the organiza-tion in meeting and exceeding corporate targets.Whereas the sales forecast and the sales plan
should be closely linked (the former should pre-
cede and influence the latter), the sales goal maybe quite independent. The objective of those
who receive a sales goal should be to beat that
goal. It
can be developed based on a sales fore-
cast, plan, and motivation levels. However, be-
cause forecasters should strive for accuracy, it is
not appropriate for a forecast to be confused
with the firm's motivational strategy.
It is particularly problematic when sales fore-casts and sales goals are intertwined, because thismixture leads to considerable game playing, es-pecially involving the sales force. If salespeople
believe that long-term forecasts will affect the
size of the next year's quota, they will be stronglymotivated to underforecast, hoping to influencethose quotas to be low and attainable. Alterna-tively, as one salesman at a parts supply companyput it, "It would be suicide for me to submit aforecast that was under my targets." In bothcases, because goals and forecasts are so inter-
wined, salespeople are motivated to "play
games" with their forecasts. There is a built-indisincentive to strive for accuracy.
Some companies have expressed a reluctanceto "manage to different numbers," suggesting thatwhen the forecast and the goals differ, it createsconfusion and lack of focus. The reaction to suchperceived confusion is to develop inaccurateforecasts that can affect performance throughout
Horizons / September-October 1998

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