Tuesday, May 17, 2005

Forecast or Feedback?

Jeffrey Miron, visiting professor of economics at Harvard University, writes in the April 2005 CEO Confidence Index Report, "In the real world, stabilizing an economy requires accurate forecasts of where the economy is headed." He continues with "forecasts are subject to substantial uncertainty" and that "Maybe economies would be better off without central banks."

Is the same true of your company? Do you need accurate forecasts of where your economy (your business) is headed in order to be successful? As Miron points out, forecasts are uncertain and grow increasingly more uncertain the further out one looks. How do you respond to that uncertainty?

It seems to me there are three answers, each potentially stronger than its predecessor.

Forecasting is first. We all forecast. If you have a $100 million dollar company this year, then, ceteris paribus, you'll likely have something close to a $100 million dollar company next year, not a $500 million (or $50 million) dollar company. Better statistical techniques can make more insightful predictions. Of course, things don't remain the same, leading to the limits to forecasting that Miron mentioned. As many say, "All forecasts are wrong," at least to some degree.

Making it happen is second. If we can't forecast the future, maybe we can drive the future. We all try that, too: we make strategic plans, we make operational plans, and we make production plans. Hopefully we execute well and get the results we want much of the time, but we can't control what our customers, our competitors, technology, governments, the economy, or the weather do, and they can all affect our outcomes.

Using feedback to build a resilient organization is the third and most important approach. If you can't predict the future and you can't control the future, you can at least think about how to respond to deviations from the forecast or plan.

There are at least two approaches that rely on the feedback of actual results to direct new actions, and they can work well together. One is scenario planning, first popularized by Shell Oil's work in the 1970s. The other is system dynamics, a computer simulation approach initially developed by Jay Forrester in the 1950s.

By simulating the effects of various policies (rules or guidelines by which you make decisions in your company), you can explore the likely outcome given a range of scenarios in your market. By the time you experience how the real world unfolds, you'll have had the opportunity to try multiple approaches and to have more insight into the results of your chosen approach.

How do you manage uncertainty and risk in your organization?

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