Read on to Discover the Six Steps to a Better Sales Forecast

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Read on to discover the six steps to a better sales forecast.

Why Most Forecasting Methodologies Fail

by David Lang

The Importance of Accurate Revenue Forecasting

The world of business is based on setting and meeting expectations. It’s all about making a promise and then fulfilling on that promise. When purchasing a product, customers expect to receive the product attributes, product quality and the value for money that has been promised by the sales rep, or by the company, in their advertising literature, etc. In the same vein, investors drive stock prices up or down based on expectations of a company's future revenues or profits. Much of that expectation is set by the revenue and profit projections - or forecasts - that are published by those companies. In most companies, the executive team sets the investors' expectations based on internal sales revenue forecasts and on the company's ability to control costs against that revenue expectation.

Unfortunately, recent history would suggest that many of our largest companies do not have a good handle on future revenues. In the past two years, many CEO’s (from Enron to Nortel) have, at best, been embarrassed or, at worst, are now spending time behind bars, in part because of revenue results that were significantly below forecasted expectations. Even if we discount those companies who used unethical or illegal tactics to deceive the investment community, the abilities of the majority of our respected organizations to accurately predict future revenues based on sales performance ranges from fair to poor. Why is this the case?

On the surface the job would seem to be relatively easy. A sales professional’s main focus is to make business happen within a predictable timeframe and create revenue as a result. A good sales representative should be maintaining and managing an active stable of opportunities at various stages in the sales cycle. This set of opportunities is known collectively as the sales frontlog and represents the identifiable future revenue of the company that is 30/60/90 days away, etc. So forecasting should simply be a matter of adding up all of the 30, 60 and 90-day opportunities.

The Complexities of Sales Forecasting

In reality the process of developing accurate sales forecasts is a highly complex one that requires significant time, knowledge and expertise to prepare. There are many variables to consider. For instance, there is a variety of external macro trends affecting the marketplace including: the health of the economy in general, the impact of competition and changes in the customer buying cycles. Then, there are macro trends that are internal to the company: including the sales process, the financing strategy, the sales and marketing strategy and the product life-cycle strategy. Finally, there are the micro trends: including the pipeline assessment of individual sales opportunities, the availability of resources required to close business, and the capabilities of individual sales professionals to move the opportunity along in the predicted timeframe. All of these factors have to be taken into consideration in order to accurately predict when, and how much, revenue will occur. For many organizations, this complexity means that the complete job is rarely, if ever, done.

The major responsibility for producing sales forecasts logically rests with the sales organization. Sales professionals are the ones closest to their own sales opportunities and should be able to determine their position in the sales process. The front-line sales manager should have the knowledge, perspective and experience to objectively assess the close probability based on the pipeline position of the opportunity and on the sales professional’s ability to move the opportunity forward in the sales cycle. Senior sales staff should have perspective to see the broader market trends and should be able to adjust the combined micro forecasts of their subordinate managers, based on their visibility into the internal and external macro trends. In theory, this combination of micro and macro forecasting should result in consistently accurate business forecasts. But what "should be" and "what is" are not always the same thing.

Building the “House of Cards”

The problem is that for the sales organization, particularly at the senior management levels, revenue forecasting is just one urgent priority, among many, and most managers are ill equipped in terms of tools, methods and motivation to do the job.

Without over generalizing, sales managers often have short attention spans and are not renowned for their deep analytical abilities. They are valued for their people relationship skills, their action orientation, and their big picture conceptual thinking to create opportunities and make deals happen.

They are usually measured and evaluated on sales results as opposed to forecasting accuracy and they, therefore, see little or no benefit in exchanging highly valued selling time for sales forecast preparation time.

This means that the typical sales manager, who prides herself on her ability to judge people, and who is faced with the excruciatingly complex task of mapping macro & micro trends against dozens, hundreds or thousands of individual sales opportunities, ends up basing her forecast, not on the strength of the opportunity frontlog, but on the credibility of her subordinate managers or sales reps. (For further information on Credibility vs. Fact Based Forecasting refer to Gartner Group research note 06/18/2002 com-16-7514, by Joe Galvin.)

She will ask them to provide her with a revenue number that they "commit" to achieve within the planning period. Then she factors or adjusts those numbers based upon her judgment or "gut-feel" about the credibility of the individual members of her team. If you asked her for her rationale you would hear comments such as, "Manager A is often too optimistic; I cut his forecast by 50%." Or, "Manager B sandbags; I can always count on him to deliver 25% more than he is promising".

The problem with this methodology is that it creates a culture of forecasting based on gut feel, not on sound business mechanics. And, if it's good enough for my boss… it must be good enough for me. This forecasting method is easier and takes less time than the painstaking effort involved in trend or opportunity analysis. So, naturally, everyone wants to emulate the boss's style and the boss tends to reinforce that style throughout the organization. As this forecasting culture permeates throughout the organization, the forecast is built successively as a house of cards. This house stays standing only as long as five factors all remain true:

The judgment of the manager is accurate. (A change of one member of the team can upset the balance in this case).
The trends on which that judgment is based remain constant. (Unfortunately trends have a nasty habit of changing when you least expect them to, the revenue results end up being way less than were forecasted and a number of managers are left with egg on their faces, or worse).
The subordinate manager has visibility, and the expertise, to apply the changes to the macro trends, both internal and external that affect her organization. (How good is the internal communication at the companies you know?)
There is at least a vestige of consistency between the reported opportunity frontlog and reality. (More often than not, we've seen CRM systems that carry more than twice the real frontlog for any given quarter).

5. The frontlog on which the forecast is based is large enough to be statistically significant. (Sales opportunities do not happen "on average". They are binary, the deal either closes or it doesn't. Gut feel forecasting is based on the law of averages - the smaller the sample size being analyzed, the greater the chance for wild swings in results).

The forecast accuracy for each layer of management is dependent on next level down having done the necessary legwork to analyze the business at both a micro and a macro level. If this analysis has not been done, or done inadequately, then a sudden change in the market – a shift in the competition, a dip in the overall economic picture will be missed - resulting in a huge miss to the forecast, and the whole house of cards comes crashing down!

Alternative Card Houses

Consciously, or unconsciously, companies have recognized the inherent weakness in sales management being wholly responsible for the sales forecast and have come up with a variety of defensive strategies aimed at improving its accuracy.

One strategy is to ignore the sales manager altogether and base the forecast directly on the information coming from the individual sales reps. In this scenario, the reps are expected to decide on their own and to report on an opportunity as "forecasted" or not. The sales forecast then becomes the sum of all forecasted opportunities.

A variation of this theme is for the reps to assign probabilities to each individually forecasted opportunity. In this case the forecast becomes the sum of each of the opportunity values multiplied by the individual probability factor.

Rarely do these methods yield accurate sales forecasts. The criterion on which an opportunity is determined to be "forecasted", or not, is usually not standardized throughout the organization - neither is the probability factor. This leads to bizarre statements that we have heard sales managers make, such as: "I usually close 50% of my 75%'ers and 30% of my 50%'ers”. Also, the individual sales rep often lacks the experience to accurately assess the "close potential" of an opportunity. How well can they assess their own sales ability and how do they ensure that they are not blinded to the elements in their sales strategy that will prevent an opportunity from closing in the predicted time frame? How can an individual sales professional have a broad enough perspective or knowledge to be able to predict the impact of external and internal macro trends on the ability to close their sales opportunities?

Further, organizations often don't pass strategic or sensitive information to Sales in a timely fashion. An example of this would be a sales rep forecasting a $1M sale of product X next quarter while, at the same time, Marketing is secretly preparing a new product launch next month of product Y that will make product X obsolete. Marketing doesn't want to tell Sales until just before the launch date for fear of tipping off the competition. But what does this lack of information do to the accuracy of the Sales forecast, particularly if Product Y's unit value is 25% less than Product X's was? So, having individual sales reps, or even first line sales managers, doing the whole forecasting exercise doesn’t really work.

Another approach that companies use to improve sales forecast accuracy is for the executive team to ask different parts of the organization to forecast sales revenue, creating a kind of “revenue forecasting contest”. Marketing produces their revenue forecasts by product, channel and sales campaign. Finance creates their forecasts according to geographical region, division or business unit. Sales produce their forecast based on the amalgamation of sales territories. Each of the forecasts is based, to a certain extent, on the sales opportunities that are being worked on in the field.

This type of forecasting process creates a whole nightmare of problems. For instance, where do the marketing managers, finance managers and sales managers go to get information about sales opportunities? To the sales force, of course. So now we have three management functions lining up to get opportunity information from the individual sales reps. Can you imagine what this does to productivity in the field? Also, it encourages Sales to keep their sales opportunities out of the frontlog system so as to avoid being "grilled" repeatedly at the end of each quarter.

Worse still, the organization now has three revenue forecasts instead of one and, guess what, they're all substantially different numbers! So more productivity is wasted while each functional department defends their forecasts numbers and while the executive team decides who’s "right".

Some clever sales managers have managed to pass off responsibility of producing a sales forecast altogether. They amass a whole team of operations or finance folk who gather and analyze the data and provide that manager with a recommended forecast number. Unfortunately these support people do not have the positional authority to drive a standardized sales forecasting process and methodology. The quality of their analysis is dependent on the quality of the information source - which too often is not very good - and they do not have the perspective to properly assess either the macro or the micro trends noted above. So they are left to paint the forecast picture with missing or incomplete information.

Six Steps to a Better Sales Forecast!

So far I've painted a pretty bleak picture on the ability of most organizations to produce a consistently accurate Sales revenue forecast. Obviously there are legitimate reasons why organizations have a hard time with this requirement. The good news is that there are a few relatively simple things that can be done that will dramatically improve an organization's sales forecast accuracy and actually improve sales performance to boot!

Here is my 6-step recipe for improving sales forecasts:

Recognize and articulate that the job is important! Too many CEO's have lost their jobs through a lack of good visibility into their own sales pipeline and too many investors have been severely burned because of a sudden drop in the sales outlook. It is time that senior management assigned the importance to revenue forecasting that it deserves and applied the appropriate focus and resources to make sure that the job gets done - consistently and properly.
Put the job where it belongs! Like it or not, the sales organization has the most visibility into what's happening with the sales opportunities and is in the best position to make judgments about the strength of the frontlog. But just handing the job to sales by itself is insufficient to realize the objective of accurate forecasts. Sales must have the following:
Forecast Process: It is critically important that there is an established forecast process. Institute standard methods and terms. The sales organization should standardize how they determine where a given sales opportunity is in the pipeline and what steps have to be completed in order for it to close and start producing revenue. Only with a consistent approach can organizations begin to measure things like probabilities of close. Both internal and external macro and micro trends can be built into the sales process to help ensure that the probabilities match with reality.

4. Institute measurement and accountability: There must be a continuity of accountability of the forecast throughout all organizational levels. Too often managers make their forecast by choosing to "adjust" for improper forecasting techniques of their subordinates. Avoid creating an environment that leads to forecasting contests. Don’t create a culture that rewards sloppy forecasting habits – i.e. sandbagging, forecasting to match financial expectations, forecasting what the boss wants to hear, being naively optimistic, not qualifying sufficiently, or forecasting by individual probability. Do implement a sales forecasting process that ensures consistency across the organization and over time.