IBM Software Group Budgeting and Forecasting White Paper Business Forecasting: Six Design Principles for Healthier Forecasts By Steve Player and Steve Morlidge, Beyond Budgeting Round Table 2 Business Forecasting: Six Design Principles for Healthier Forecasts Executive summary Achieving hardy performance over the long term requires Key takeaways businesses to develop healthy forecasting processes. 1. Traditional budgeting and forecasting practices Forecasting health can be developed, or restored, by frequently fall short of improving performance health; adhering to the six principles presented in this paper. in many cases, traditional budgeting and forecasting practices actually contribute to performance woes. Finance managers whose organizations are just beginning their 2. Eliminating unhealthy forecasting practices is a journeys to healthier forecasting processes should consider must, but it is not sufficient; finance managers reading the first installment in thisBusiness Forecasting white can, and should, develop a regimen of healthy paper series. That paper, “Seven Symptoms of Forecasting forecasting practices that support the achievement Illness,” examines prevalent maladies that commonly plague of strategic objectives. traditional budgeting and forecasting activities. 3. The implementation of the six business forecasting principles identified in this paper can help finance The successful implementation of a rolling forecasting managers create and implement a forecasting process approach requires consideration and execution of the that aligns with, and enables the execution of, following six principles: corporate strategy. • Understand the characteristics of a healthy forecasting process • Recognize the impact of reaction times • Treat each system appropriately • Take vital signs • Understand variations within the body • Live healthfully This paper provides a case example of successful rolling forecasts in practice and examines the nature and requirements of each of the six business forecasting principles. Budgeting and Forecasting 3 Introduction Future Ready Much of the discussion in this white paper, as with the If you focus on results, you will never change. other papers in this Business Forecasting series, is inspired If you focus on change, you will get results. by a collaboration between the IBM Cognos Innovation Center for Performance Management and Steve Player -- Jack Dixon (Author of historical fictional novels) and Steve Morlidge, authors of Future Ready: How to Master Business Forecasting (Wiley, 2010). The book’s premise is a straightforward one: When making The first step to better health is recognizing what ails you. decisions, organizations cannot rely solely on information about what has happened. Instead, As any elite athlete knows, the key to superior performance companies also need information about what its depends on more than the elimination of detrimental habits. managers believe might happen – information that is A healthy regimen should be implemented and followed. generated through the process of forecasting. To date, the bulk of business forecasting practices have ranged The same holds true from a business perspective, particularly from ineffective to downright crippling. No company, in the realm of forecasting, planning and budgeting. and no individual, can predict the future with complete certainty. Therefore, the objective of business The previous entry in this Business Forecasting white paper forecasting should be to become “Future Ready.” series, “Seven Symptoms of Forecasting Illnesses,” showed Companies can do this by systematically and rationally finance managers how to detect and remedy seven different assembling information that gives managers forward problems that commonly plague forecasting processes. This visibility regarding likely outcomes as well as the paper builds on that foundation by examining the six design potential losses and opportunities (i.e., the risks) principles of robust business forecasting: associated with these outcomes. • Understand the characteristics of a healthy forecasting process. • Recognize the impact of reaction times. • Treat each system appropriately. • Take vital signs. • Understand variations within the body. • Live healthfully. 4 Business Forecasting: Six Design Principles for Healthier Forecasts How the principles pay off The sales pitch worked—as did the larger change effort. The By adhering to principles listed above, companies can company now completes a rolling forecast four times a year, strengthen their daily performance over the long-term. Tw and this process requires less time that the previous annual telecom, for example, recently relied on these principles to budgeting exercise. The time-savings frees up corporate make good on a resolution the company issued entering the finance to invest more time to help run the business from recent recession: avoiding employee layoffs. a strategic perspective rather than fretting over insignificant budget variances. A Beyond Budgeting practitioner since 2004, tw telecom is a leading provider of managed networking solutions to “We’ve followed this rolling forecast method since the end a wide array of businesses and organizations throughout of 2004, so we have a rhythm going,” says Peters. “The the United States. accuracy improves every single time; you get much more precise. And the pain level is so much lower.” “We would take it as a bit of a failure if we had to lay people off, because this would mean that we aren’t planning properly,” Companies and managers who want to reduce their own Mark Peters, executive vice president and CFO of tw telecom, forecasting-related pain can start adhering to the following says of the company’s resolution. “Never say ‘never,’ but being six principles. able to avoid large layoffs is a real advantage because it means that we’ve avoided the disruption in productivity and morale Principle 1: Understand the characteristics they cause, plus we’ve retained the capacity to ramp up quickly of a healthy forecasting process once we return to higher growth with a stronger economy.” Business forecasting can improve an organization’s overall health by identifying the actions necessary to move from the Tw telecom replaced a highly detailed, spreadsheet-intensive current situation (that is, reality) to a better future (that is, the annual budgeting process with a six-month rolling forecast, achievement of a strategic objective or target). in large part, because of management’s frustration with the exercise. “You spend three months doing [the traditional Although it makes sense to plan before enacting an budget] … and, inevitably, by the time you’re done, it’s old improvement program, the original plan (traditionally defined news,” Peters adds. “It doesn’t provide a foundation for an as the “budget”) frequently—and quickly—becomes outdated agile company.” because of changes in underlying business conditions. This is why it makes more sense to forecast where performance is So, tw telecom focused on change. Because managers going. By doing so, organizations can use that information to throughout the organization were accustomed to holding their identify the corrective actions necessary to better ensure that sales and operations employees responsible for achieving a future performance achieves strategic objectives. specific budget number, Peters and his team continually communicated the value of adaptability over accountability; When developing a forecast, managers should distinguish specifically, they emphasized the futility of holding people between a “forecast” (where you think you will be) and a target accountable to numbers that were outdated by the time they (where you want to be). were produced through the traditional budgeting process. Budgeting and Forecasting 5 Too often, a gap exists between a forecast and a target, at least • Aligned. When addressing multiple health issues, doctors until the appropriate corrective decisions and actions take take time to evaluate the interaction of different medicines place. Even then, however, this gap is likely to reappear, even and treatments. The objective is to make sure that the in the most stable business environments. medications are safe when delivered in combination. Addressing the performance health of a company requires a For these reasons, managers should understand the qualities similar approach. Within companies, different treatments or that define a healthy forecast. A healthy forecast is: medicines equate to the competing versions of the truth that various organizational groups often promulgate for self- • Timely. If a company’s performance shows warning signs, a serving reasons. These motivations and multiple performance rough-and-ready forecast delivered quickly is much more projections can cause highly negative reactions. Companies valuable than a painstakingly detailed forecast that arrives too should settle on a single treatment when creating forecasts late to drive corrective action. and, when the need arises, for re-forecasting also. • Actionable. Too much detail, or the wrong details, can limit • Cost-effective. While every process needs to be cost- the forecast’s effectiveness. Only include details that are effective, this quality marks a critical, and often relevant to decision-making. Also, keep in mind that forecasts misunderstood, specification that warrants an explanation. should contain different information than budgets contain. First, evaluating cost requires valuable soul-searching about Forecasts typically