Forecasting

Forecasting is extremely important.  It drives all aspects of a company’s business.  Forecasting drives pricing decisions, strategic planning, manpower levels, assets such as trucks, ships or airplanes, etc.  More accurate forecasting results in a company being more efficient.  Forecasts allow companies to run revenue simulations as well as cost simulations to allow management to run a company better.  As discussed in the Capacity Management article I will expand the model to show where forecasting fits in the Revenue Management model.  Since capacity is fixed in the short-term, forecasting is used between the Pricing side and the Revenue/Capacity Management areas.

In this article I will speak to the concept of forecasting, however I will not dive into the mathematical models.  That should be reserved for consulting exercises that specialize in analyzing each company’s needs.  But what I can tell you is there are many, many forecasting methods and models that will give different predictions, with each model specialized for a different situation.  What is important is to find a forecasting model that is right for your company and situation.  And there can be different forecasts for different purposes so it is not uncommon to have multiple forecasts in a company.

As an example I have often seen the Finance department set inflated goals in order to make the next year’s business plan meet certain financial targets on paper.  This is known as “cooking” a forecast, however, if you use that Finance forecast in your pricing models it will send the message that the market is strong and prices should rise.  This will falsely put the company into a negative situation because sales will fall due to higher than market prices.  On the other hand if the Sales department gets their way then the forecasts will be soft (known as sandbagging) so they can easily achieve their revenue goals.  But that will result in prices being lower than market because the demand forecast will be soft and will make achieving the overall revenue goal much more difficult, and leaving revenue on the table.     

It is important that Pricing and Revenue Management developed their own forecasts independently without the political influences from other departments in the company.  Usually the forecasts are done monthly to provide a general plan for the following month.  The forecasts are then updated on a rolling weekly basis, and some companies such as airlines and hotels even update their forecasts daily for the following seven days as bookings occur. 

This may seem like a lot of effort but forecast accuracy can have dramatic improvements in a company’s revenue and profit.  Several studies have shown a 10 percent improvement in forecast accuracy can increase revenue and yields by 1 percent.  And that 1 percent goes straight to the bottom line improving profits by up to 20 percent.  And more accurate forecasts can also save costs by allowing manpower and assets to be right-sized accordingly.

Forecasting is very serious and should be taken seriously by companies to put the effort into this process and not cut corners in order to save expenses.  It will more than pay for itself as an investment.