Friday, September 01, 2006

A Pessimistic Sales Forecast is not an Oxymoron

So far we have only discussed potential root causes for inflated forecasts. Despite their ingrained optimism, sales people under certain circumstances produce deflated forecasts, meaning they turn out to be lower than actual sales.

If you were to plot a time series of actual versus forecasted sales, chances are that you discover that under forecasting (producing a deflated forecast) is a seasonal effect. If you find such seasonal patterns, make sure that they are not caused by seasonality in demand not correctly understood by the sales force. If the seasonal pattern is not an effect of the demand variation you, might want to look for possible root causes due to a certain behavior of your sales people.

Let us first discuss a potential root cause for a yearly recurring pattern for under forecasting. If you find that the period where forecasts are too low correlates with the time in the yearly calendar, where quota setting sets in, you know what is happening. Your people want to avoid to be confronted with too high a quota for the next fiscal year. If you have a culture of over achievement and an uncapped variable compensation structure, the motivation for under forecasting during the quota setting period is even bigger.

A capped variable compensation structure is however not necessary the solution to this problem. This compensation structure, can cause a quarterly pattern of over forecasting. If sales people can make their quota let us say in 2 months, their motivation to work with the same intensity in the 3rd month of the quarter is minimal. This effort will not bring more revenue to them due to the capped variable compensation structure. This behavior leads to an inflated forecast, if you as the leader of the sales force base your expectation for the 3rd month of the quarter on what you saw coming in in sales the previous 2 months. The old rule “you get what you pay for “ is at work here.

Systematic bias for under forecasting is rare. I believe the reason for this lays in the fact, that sales people experience directly the effects of systematically deflated forecasts. Sooner or later under forecasting must lead to the situation where the supply chain cannot satisfy demand. This will lead to dropping customer service levels. The first one to be confronted with an unhappy customer is the sales person. The fear alone that service levels might drop due to capacity limits in the supply chain can actually lead again to inflated forecasts. This phenomenon is worth a separate future entry to this Blog.

Let us end today’s entry with discussing why inflated forecast by sales forces do not have an automatic corrective effect over time. The consequences for over forecasting are not felt so directly, if at all by the sales force. The sales person I told you about yesterday, thinking of the consequences of over forecasting for the supply chain is the exception not the norm. The effects of over forecasting are more the concern of the operations and finance people. They have to face the consequences for bloated or obsolete inventories. That these inventories might lead to discounted offerings and thus making it potentially harder for the sales person to make quota is probably too far a stretch for the average sales person to grasp.

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