Section 1
âWHY?â
The purpose of this short section is to set out the arguments for change; for doing a better job of forecasting.
Failures of forecasting can be disastrous, and as the world becomes more turbulent and unpredictable, holding a true course and dealing with business stakeholders becomes more difficult and the risk of outright failure more real. Senior management in businesses recognizes this, and has for some time. Why is it that we seem to have made so little progress? Why do we see the same problems presenting themselves in business after business?
This section is for all readers. The first part provides a better understanding of the nature and the source of the problems of forecasting in business. In the second part readers are helped to diagnose forecasting diseases and we give guidance on potential cures. In addition, we paint a picture of the kind of benefits you can expect if you succeed in applying what can be learned from this book.
Chapter 1 Part 2
WHY CHANGE? Everyone knows the trouble Iâve seen
âPrediction is very difficult, especially if itâs about the future.â
Nils Bohr, Nobel laureate in Physics
What happens when forecasting fails â why forecasting is more important than ever â why we canât blame âthe Streetâ for our failures â what managers think about forecasting â how traditional management models make things more difficult â common symptoms of a failing process â remedies that donât work and one that does â what success looks like â and the benefits
Sometimes, as with the human body, you only recognize how a management practice contributes to organizational health when it fails. This is the case with forecasting; almost every economic crash or catastrophic business failure is accompanied by the lament âhow come no one saw it coming?â
The birth of an empire
We open with two such stories. The first concerns the company founded by the Italian Irish inventor Guglielmo Marconi, the man credited with the invention of the radio. He first demonstrated the ability to send radio messages across the Atlantic in 1901, but his invention shot to fame when it was used to apprehend the wife murderer Hawley Harvey Crippen, after the captain of the ship carrying him and his new partner to Canada had radioed his suspicions of their identity to Scotland Yard. One hundred years later, at what turned out to be a particularly inauspicious time, the company bearing his name was preparing to celebrate the anniversary by launching a new ÂŁ 0.5m website commemorating the life and works of the great man. âWe like to draw the parallel between the man 100 years ago and the company and its potential nowâ said Peter Crane, the man behind the project (Solomans, 2001).
The companyâs journey through the previous century however had not been straightforward. Marconiâs company had been acquired by English Electric in the 1940s, which was itself taken over by GEC in 1968. GEC was the creation of Arnold Weinstock, the son of an immigrant Polish tailor, who, over 40 years had presided over the rationalization of the British electrical industry. Weinstock was a notoriously meticulous and cautious man, poring over the numbers of his various companies and deals in his dingy Stanhope Gate offices, surrounded by trusted lieutenants. By the time he retired in 1996, he had built up a conglomerate with profits of over ÂŁ 1 billion on turnover of ÂŁ 11 billion. More to the point, he bequeathed a cash pile of ÂŁ 1.4 billion to his nominated successor George Simpson.
Weinstock divided opinion strongly. To many he was simply âBritainâs best managerâ. To others he was a narrow-minded bean counter who had sucked all the life out of a major chunk of Britainâs industry, leaving the country ill equipped to exploit the opportunities of the new digital era.
Lord Simpson addressed the challenge of reversing this trend with gusto. He recruited John Mayo, a high flying merchant banker, sold off GECâs unfashionable defense businesses and used the proceeds of this and the equally unfashionable cash mountain to buy Marconi (as GEC was now called) a stake in the new economy.
âSimpson continued to buy telecoms assets as if they were going out of fashionâ BBC business pundit Jeff Randall drily observed. âUnfortunately for him they wereâ (Randall, 2001).
A bubble bursts
The second, related, story is about the poster child for the new digital age: a company called Cisco. Founded by a husband and wife team in 1986 it had, in a mere 14 years, become the worldâs most valuable company when in March 2000 its shares hit $ 80 (50 times earnings). The engine of this growth was Ciscoâs dominant position in the switching technology underpinning the Internet. In 1990, there were 200000 Internet hosts. By the end of the decade there were over 100 million.
Barely a year after this peak, however, Ciscoâs CEO, John Chambers, was having a miserable time. On May 10, 2001 he announced Ciscoâs first ever quarterly loss. The loss Cisco posted for Q1 was a massive $2.89 billion on revenues down 30% on the prior year quarter, when sales had posted year on year growth of 70%. The decline was across all sectors and all territories. Over the next few months most of Ciscoâs competitors, customers and suppliers were to follow suit.
Chambers compared what had happened to a biblical disaster: âthis shows that a once in 100 year flood can happen in your lifetime. It is now clear to us that the peaks in this new economy will be much higher and the valleys much lower and the movement between these peaks and valleys will be much faster,â he went on. âWe are now in a valley very much deeper than any of us anticipatedâ (Abrahams, 2001).
The drop in the market was only half of the story, however. Based on overoptimistic sales forecasts Cisco had taken a gamble. To avoid losing sales because of a shortage of components, the company had bought stock ahead. The reason why Q1âs results were so bad was that the company was forced to write off $ 2.25 billion of excess inventory â bringing the total inventory the company carried down to a mere $1.9 billion.
Chambers reported to analysts that visibility remained difficult. âThe suspicion remainsâ reported the Financial Times âthat visibility is fine; it is merely that management does not like what it seesâ (Abrahams, 2001).
By the end of May Cisco had lost over 75% of its March 2000 value and 25% of its employees had lost 100% of their jobs.
The calm ... and the storm
On the day after Ciscoâs announcement, in Liverpool - home to one of Marconiâs 70 odd factories - the visibility was also fine. The city was enjoying a spell of unseasonably hot weather and so management sent workers at the plant out to sunbathe on the lawns in front of the glass-fronted buildings of the Edge Hill factory. Talk was of the plane crash at the cityâs airport and the following dayâs football FA Cup Final, which featured one of the cityâs two big teams. What also featured in conversations was the shortage of orders that had led to this unofficial break. âThere were simply no orders going through for hardwareâ reported one of the workers (Daniel and Pretzlik, 2001). This did not come as a surprise to employees of the plant. In the period January to March when the plantâs major customer, British Telecom, spends most of its money, workers âusually work around the clock, seven days a week because there is a flood of workâ. But this year âwork dried up â it was already quiet over the Christmas periodâ reported Sue Tallon, a union representative at Edge Hill.
Management only seems to have noticed this much later. On April 9, senior management gave an upbeat presentation to union representatives at the Coventry plant. It employed 1200 people but was operating at below 50% capacity. In Italy, Elio Troilli, the head of the workersâ committee for Marconi plants there, says they began getting reports of a slowdown in orders at the beginning of the year.
Marconiâs management was having none of this negative thinking however. On April 11, the Financial Times ran an article with the headline âMarconi starts an assault on doomsayersâ (Daniel, 2001). âWe have not needed to change our guidance,â Mayo said to the FT reporter. âIf we had come out each month saying âwe havenât changed our guidanceâ people would have thought we were off our trolleys.â He based his confidence on the companyâs limited exposure to alternative carriers and the US enterprise market, its focus on âsolutionsâ rather than âproductsâ and its dominant position in optical networking outside the US. âThe history books will probably write that we were Lucentâs nemesis. Nortel and us have taken share from them.â
The company continued in this optimistic vein. At the annual shareholdersâ meeting on May 15, Lord Simpson commented that while the first half of the year would be flat âwe anticipate that the market will recover around the end of this calendar yearâ. On June 19, he told the FT that âwe have no reason to change our view of what we said a month agoâ (Daniel et al., 2001).
But, when the âflash resultsâ came into Marconiâs new Mayfair headquarters at the end of June it was clear that performance in the first quarter of the financial year was not merely weak; it was disastrous. Mayo flew back from a sales trip to Italy on the morning of Tuesday July 3 to go through the figures with Steve Hare, the Finance Director. At 6.26am on the following day, Marconi announced the completion of the sale of its medical unit to Philips, the Dutch electrical group. Fifteen minutes later the shares of the company were suspended. At 6.53pm, the Board of Marconi issued a trading statement. Sales would be 15% below the level of the previous year and profits halved. Four thousand jobs would be lost. âNormally, at the end of June we would see a sudden uptick in performance as orders are finalized at the end of the quarter. Instead what we saw in fact was a downturn ... it did just happen that quicklyâ reported Lord Simpson (Daniel and Pretzlik, 2001).
The next day Marconi shares fell 54%. They closed at 101 pence valuing the company at ÂŁ2.6 billion compared to ÂŁ35.5 billion nearly a year earlier. By September analysts had concluded that the shares were âvirtually worthlessâ (McCarthy, 2001).
By Friday evening of that same week, Mayo had been forced to resign. The Chairman of Marconi, Sir Roger Hurn, and Simpson resigned in September after a second profit warning. Steve Hare, the FD, lasted until November 2002 when he lost his job following a failure to renegotiate debt financing for the company.
Unfortunately, Lord Weinstock did not last that long. He passed away on July 24, 2002 after a short illness. âHe was the best manager Britain has ever producedâ according to Lord Hanson, the industrialist. âI think he died of a broken heart because of what happened to his company.â âWatching Marconi slowly collapse like a great classical building was extremely painful for him,â said Sir David Scholey, friend and one time banker to Weinstock (Hunt and Roberts, 2002).
In 2005, at the end of âone of the swiftest ever exercises in value destructionâ (Plender, 2002), the bulk of what was left of Marconi was sold to Ericsson, the Swedish company, for ÂŁ 1.2 billion.
The world has changed, but our thinking and our tools have not kept pace
What do these stories teach us?
Clearly, growth through acquisition can be risky; most fail to deliver the anticipated benefits and many lead to calamity. And Marconi were certainly unlucky or unwise since they bought at the top of the market. Also, the simplistic, narrow minded focus on a single financial metric, particularly when it is linked to generous financial incentives, can be, as we have discovered again recently, a recipe for disaster (Plender, 2002).
All these, and many other criticisms may be valid, but there is something more profound, more relevant to the daily practice of management, that these stories illustrate.
It is clear that our modern economies have evolved to the point that things can happen at a frightening speed. Start-ups can become huge, globally dominant corporations in a matter of a few years; for example, Google has only just celebrated its tenth birthday. Conversely, as we have discovered over the past year, institutions that have been around for a century can disappear almost overnight. Economies and institutions are now so interconnected that it can be dangerous to make assumptions about the business environment more than a few months ahead.
It follows from this that businesses have to pay more attention to the opaque nature of the future than ever before. Opting out of the global economy is not an option, and there is a limit to our ability to manage risk â the product of our inability to forecast perfectly â using tools such as insurance, hedges or diversification. If we cannot avoid business risk altogether, and it is not possible to insulate ourselves against it, we have to get better at anticipating danger - or for that matter opportunity - and responding to it, quickly and effectively. We have to become âFuture Readyâ.
That is the real story here. When making decisions, we cannot rely solely on information about what has happened, we need information about what we believe might happen as well; information that we create through the process of forecasting. Equally important, we then have to build the capability to act upon this information. If we have no such information, or it is deficient or misleading, then we risk loss of opportunity, resources or, in the case of Marconi, outrig...