Clearly, the traditional model of using historical volumes to predict future sales to generate five year business plans is broken. The economic conditions of the past three years have created historical volumes that are no longer predictive of future activity. Manufacturing and service companies alike are turning to more disciplined, creative methods of projecting in order to create long term business plans that are meaningful.
While the global economic conditions over the past three years may fall within range of predictable economic activity using extremely long business cycles; they have resulted in a disruption of the short term business cycle for most companies.
Businesses must consider two things:
- No longer are historical sales from the past decade predictive of future sales
- Anyone who is still developing five year business plans has a tremendous amount of uncertainty surrounding volumes
There simply is not enough data to reliably predict the new baseline level of economic activity. In fact, the only constant in all of the theories about long term business cycles is the unpredictability in the length of the individual mini cycles.
Is Your Business Plan Current?
From the National Bank of Greece to the community hospital down the street, three to five year business plans were abandoned in 2009 and 2010 in the face of plummeting revenues. But while executives and government leaders are trying to refocus their lenses to peer down the road, the plant managers and team leaders still have to order steel and publish next week’s shift schedule. We are observing that business leaders are beginning to feel more secure in the economic recovery so strategic planning executives are dusting off their 4” binders and sending out schedules. While Business Plans are very important for the long term health of an organization, an effective bridge to short term success lies in a rigorous review of practical volumes.
So a typical executive today is balancing the need to develop a vision for the future, thinking beyond short term fluctuations, with the day to day reality of minimizing costs and inventories while optimizing capacity utilization. The single most important assumption of a business plan, on which all other assumptions are hinged, is sales volume. Industry volume projections are valuable tools, but Ducker finds that making individual company projections based on market penetration of an industry is taking an expensive shortcut. Using extrapolated data and syndicated studies help to define the general market in which a company operates, but detailed understanding of the numbers is essential to good decision-making for an individual organization.
New Opportunities in Old Markets
The changing landscape of material usage in the automotive sector is a great example of new market opportunities arising in a mature industry. Automotive suppliers not only need to know that industry projections are for 14.2 million light vehicle sales units in North America for 2011, but they need to know what kind of vehicles are in that 14.2 million (trucks, SUVs, passenger cars), with which drivetrains and what new options and of which materials. For instance, suppliers need to know how the mix is shifting in terms of types of material usage. As fuel prices fluctuate, the break-even analyses change for some of the new lightweight materials so the volume projections must respond to these market conditions.
No Short Cuts in Volume Projections
Understanding every element of market conditions is critical to both the long-term strategic planning function, as well as the daily operations. Successful companies will be looking to understand every aspect of their market. The executive will be making decisions about aligning product offerings with market conditions through acquisitional or organic growth, or divestiture, while managers will be making hiring and purchasing decisions based on immediate needs.
Short term rationalization of the cost structure by managers will buy time for the visionary executive who is planning the next steps for the organization.
In depth understanding of the underpinnings of a company’s volumes are critical. External factors that could have an impact on volumes include:
- Government regulations
- Fuel prices
- Raw materials
- Competitors’ positions
- Volumes in related industries (both up and down stream)
- Technological advancements
- Availability of alternative products
- Public perception/trends
Factors internal to an organization that can affect volumes include:
- Product improvement
- Capacity availability
- Labor conditions
- Logistics and inventory management issues
- Effectiveness of existing distribution channels
- Utilization of purchasing leverage
- Marketing initiatives, and of course
- Availability of capital for any kind of investments
How to Grow
Product by product, customer by customer, in-depth understanding of one’s market conditions will reap rewards for all organizations. Once accurate volume projections are developed, managers will work within the confines of the limitations that are presented to them: they must minimize cost, seek the best suppliers, push the marketing advantages available to them; basically execute the one year budget to the best of their abilities.
Visionary leaders begin with the complex volume projection models, and then try to remove the limitations presented in the models: how can the company grow its product offerings (product development, multi-purposing, repackaging, acquisition), expand its production capabilities (invest in production facilities, leverage existing suppliers, develop new partnerships), improve its marketing presence (spend money on marketing initiatives –advertising and PR, expand distribution networks through investment or partnerships) and obtain funding to accomplish all of these initiatives.
Private Equity Lessons
The private equity environment knows the volume lesson well. Industry volumes are not the sole basis for company volume projections. The opportunity for arbitrage exists when a company has unique access to a segment of the market that others do not, or when the market conditions imply volumes that are not reflective of an individual company’s outlook. When someone is willing to dig deeper and work harder to fully understand a company’s volumes, they have a knowledge advantage over those who are taking shortcuts by looking mostly at industry volumes. That knowledge translates into more accurate valuations and more profitable transactions.
Even for those companies not looking to buy or sell operations, valuation models are critical to maintaining access to capital. Any company that is looking for financing should understand their volumes BETTER than those on the other side of the negotiating table. Lenders are as strict as new investors about assessing the risk associated with all of their transactions. Demonstrating the ability to repay loans with future cash flows is the most important factor.