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One Number

Any business operates an annual budget process. Once done, this budget is hardly touched or modified during the fiscal year of execution. Targets for sales, production or other departments are derived from those budgets and used as performance targets for the fiscal year to come by each department.

As the fiscal year is passing by, monthly or weekly updates to a demand plan or a sales forecast are being applied. In any organization, a gap between budget or targets AND the demand plan or sales forecast will sooner or later appear. Whilst the desire for senior management to manage the business against a single number, i.e. the budget or target, they are much less comfortable with managing the gap.

Neither adjusting the demand plan or sales forecast to the budget or target, nor the opposite, are useful mechanisms to manage the performance gap.

One Number

 

The Components of Performance Management

Let us review the components of proper performance management first. There are four components:

  • The Budget: the financial statement of revenue and cost for the next fiscal year
  • The Target: the translation of the budget into departmental sales and cost targets
  • The Sales Forecast: regular estimation of projected sales for each sales channel
  • The Demand: sales forecast adjusted for consensus inputs, including customer orders

Budgets are developed and agreed to set the entire financial plan for the upcoming fiscal year and to manage the revenue and cost variance throughout the year.

Targets are developed from the budgets, and in particular for sales often include stretch targets knowing that the sales organization varies in its performance and ability to sell. Usually set higher than budgets, they are set to ensure that the budget is met at the end of the fiscal year.

Sales forecasts are calculated either manually through input from the sales teams, or systematically through forecast algorithms. A sales forecast should reflect what is expected to be sold. The process is run periodically for a rolling horizon of 12 to 18 months. The sales forecast must be owned by the sales organization.

Demand plans have various inputs. They include the sales forecast, adjustments coming from a consensus meeting reflecting management targets or any known events, as well as including the customer order book information. The demand plan can we lower but is usually higher than the sales forecast. Often the demand plan is forced into a revenue projection and not into a pure sales projection, which changes the view of what a demand plan should represent. The demand planning process is run periodically for a rolling horizon of 12 to 18 months.

By the virtue of the activities above, those number will never align. More importantly, they should not align. The resulting gap is desired and must be used for performance management across the organization.

The Gap

What does a gap represent? It simple indicates to the management of an organization where the current performance deviates from the budget and targets. It is a call for action. The gap can indicate that:

  • promotions must be put in place because the sales forecast and demand plan are insufficient to reach the targets, or
  • demand should be shaped, using market insights and prescriptive analytics to design and drive the right demand shaping actions, or
  • that the sales pipeline is not strong enough and that the sales team needs to increase or improve their selling activities, or
  • that the sales pipeline and order intake is stronger than expected and that immediate actions need to be taken on the supply side, or
  • that the product range or assortment are out of tune with the market needs, or
  • the wrong product mix and inventory positions have been put in place, or
  • there can be many other reasons

The worst mistake an organization can make is to increase the sales forecast or demand plan to match the budget or target, and then has no plan in place how to get there. It is easy to change a number on a spreadsheet, it is difficult to make this happen in the market.

One number as a single objective to manage an organization against does not exist. Different number serving different purposes and showing a gap is what an organization needs, and then manage performance and related correcting activities accordingly.

The Consequence of the Gap

One of the key decisions resulting from a demand plan or sales forecast is how much inventory needs to be put in place or how much capacity needs to be reserved. In both cases the results into a buy decision by a market operation of an organization. Pushing the sales forecast or demand plan to match a budget or target will result in excessive inventory without a plan how to deal with it. This is a dangerous situation for any organization spending working capital and then understanding what the risk associated to that overbuy is.

A risk buy (e.g. buying above the demand plan) is not necessarily wrong, as long as an organization understands the gap, has meaning actions in place and hence understands the risk profile of the buy (please refer to our article “Probability instead of Accuracy as a Measure in Forecasting” on how to manage risk levels).