• Strategy
  • The Economist

Managing in the Fog

The struggle to make meaningful forecasts in a downturn.

“Not to beat around the bush, but the budgeting process at most companies has to be the most ineffective practice in management.” Thus Jack Welch, the former boss of GE, in his book “Winning,” which was published several years ago. Many firms that put their 2009 budgets together at the end of last year will no doubt agree with him. Most of them will have already been consigned to the shredder, as the economic crisis has blown away the assumptions on which they were based.

Faced with exceptionally volatile business conditions, senior executives are finding it harder than ever to gauge how their companies are likely to fare in the months ahead. According to a recent global survey of 1,300 chief financial officers (CFOs) by Tilburg University in the Netherlands, America’s Duke University and CFO Europe magazine, a sister title of The Economist, finance chiefs say that the struggle to produce accurate forecasts now tops the list of things that keep them awake at night.

With even short-term horizons as obscure as the San Francisco skyline during a summer fog, companies are finding their standard budgeting and forecasting of little use. The usual trick of plugging figures from operating units into spreadsheets appeals to number-crunchers, but can often generate misleading targets, especially when conditions change fast. “The annual budget is even less of a meaningful document this year than usual,” argues Cynthia Jamison of Tatum, a consulting firm that also provides clients with interim CFOs.

What can companies do? A few forward-thinking firms can provide inspiration. Hugh Courtney, a professor at the University of Maryland’s Robert H. Smith School of Business, thinks more companies should be using “scenario planning” alongside their financial models, which do not produce a large enough spread of possible outcomes to capture the flavour of today’s uncertainties. Sten Daugaard, the finance chief of Lego, a Danish toymaker, says his firm generated a number of different scenarios as part of its 2009 budget, the first time it had used such an approach. It has developed contingency plans for each scenario so that it can react swiftly whatever the coming months throw at it.

Lego has also been using a monthly meeting of senior managers, known as the operations board, to pool knowledge of what is happening in its various markets. At each get-together, the firm’s executives not only discuss what has been going on that month, but also make their best guess about what is likely to happen in the 12 months to come.

Some companies have formalised this kind of approach by creating “rolling forecasts”. At the end of, say, the first quarter of a financial year, managers forecast the remaining three quarters again and then add an extra quarter’s projections, worrying about only the most important financial variables. Many companies in Europe already use such systems, says Emery Sinclair of Revelwood, an American software-services provider, and firms in America are suddenly taking a lot more interest in them. One benefit of rolling forecasts is that they discourage executives from becoming too fixated on the present at the expense of the future.

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