Practical Goal-Setting: Benchmarking and Forecasting your Industry End Markets Presented at the Economic, Industry and Consumer Outlook Seminar April 29,

Copyright 2002 Global Insight, Inc.

Practical Goal-Setting: Benchmarking and Practical Goal-Setting: Benchmarking and Forecasting your Industry End Markets Forecasting your Industry End Markets

Presented at the Economic, Industry and Consumer Outlook SeminarPresented at the Economic, Industry and Consumer Outlook Seminar

April 29, 2003April 29, 2003

Atlanta, GeorgiaAtlanta, Georgia

Allen GutheimAllen Gutheim

Principal, Advisory Services GroupPrincipal, Advisory Services Group


What We Will Talk About TodayWhat We Will Talk About Today

• The forecast process:The forecast process:• What would we like to achieve?

• What’s realistic?

• Forecasting methodology:Forecasting methodology:• B2B “Sales Benchmarking” at Global Insight.

• Elements of our techniques that can work for you.

• Tricks of the trade.

• Achieving forecast user buy-in.Achieving forecast user buy-in.• Senior planning executives.

• Senior operational executives.


Forecasting Occurs in a Difficult Forecasting Occurs in a Difficult Environment Environment

• Many participants.Many participants.

• Conflicting motivations.Conflicting motivations.

• Imperfect knowledge.Imperfect knowledge.

• Cumbersome process.Cumbersome process.

• Time-killer.Time-killer.

$$$


Forecasting at Many OrganizationsForecasting at Many Organizations

• Start with last year’s Start with last year’s sales results.sales results.

• Assume a reasonable Assume a reasonable increase for the increase for the budget period.budget period.

• Bend into a “hockey Bend into a “hockey stick.” stick.”

• Review with boss.Review with boss.

• BIGBIG difference between difference between your number and your your number and your boss’ number.boss’ number.

• Go back to beginning for Go back to beginning for another round. another round.

The CEO has a number in mind, but may not share it.


Organizational Dynamics Weigh Organizational Dynamics Weigh Against the Forecast ProcessAgainst the Forecast Process

• Forecasts are mistrusted.Forecasts are mistrusted.• They are often wrong.

• The process is highly political.• Careers hinge on achieving results against plan.

• Forecasts must serve multiple goals or ends.Forecasts must serve multiple goals or ends.• The forecasting methodology varies across the organization.The forecasting methodology varies across the organization.

• Underlying forecast assumptions.

• Future outlooks or forecasts.

• Individual biases affect forecasts and quotas.Individual biases affect forecasts and quotas.• The process seems illogical.The process seems illogical.

• No well-established and accepted foundation.

• Difficult to analyze and discuss, and to manage to.• Things change as the year goes on.


Sales Benchmarking is Designed to Sales Benchmarking is Designed to Optimize the Forecasting Process Optimize the Forecasting Process

Unbiased—replaces capricious underlying

assumptions with a standard

macroeconomic perspective.

Unbiased—replaces capricious underlying

assumptions with a standard

macroeconomic perspective.

Standardized—unifies the organization’s

forecast process with a logical, rational, and

consistent methodology.

Standardized—unifies the organization’s

forecast process with a logical, rational, and

consistent methodology.

Understandable—facilitates the use of

the forecast as a planning tool. Not a

black box.

Understandable—facilitates the use of

the forecast as a planning tool. Not a

black box.

Precise—Not restricted to aggregate macro

indicators--it pushes into the market niches

served by the company.

Precise—Not restricted to aggregate macro

indicators--it pushes into the market niches

served by the company.


A Sales Benchmarking PerspectiveA Sales Benchmarking Perspective

Business activity in its end markets

Shifts in market share

Special events

Strong market activity provides a growing demand for a company’s products.Strong market activity provides a growing demand for a company’s products.

Successful responses to competitive challenges contribute to additional growth.Successful responses to competitive challenges contribute to additional growth.

A variety of events (often one-time) can significantly affect revenue growth.A variety of events (often one-time) can significantly affect revenue growth.

Ultimately, only three elements determine a company’s sales growth:


Sales Benchmarking is a Simple, Sales Benchmarking is a Simple, Three-Step ProcessThree-Step Process

Step Two

Step Three

Carefully define your company’s end-market structure. Carefully define your company’s end-market structure.

Construct a custom market index from available business and economic activity indicators that capture the client’s participation in each end market.

Construct a custom market index from available business and economic activity indicators that capture the client’s participation in each end market.

Identify and evaluates the factors that contribute to deviations of historical sales from the market index.

Identify and evaluates the factors that contribute to deviations of historical sales from the market index.

Step One


Sales Forecasts that are Logical, Easily Sales Forecasts that are Logical, Easily Understood and CommunicatedUnderstood and Communicated

Custom Market Index:• Captures the business

basis for growing demand for the company’s products.

Custom Market Index:• Captures the business

basis for growing demand for the company’s products.

Additional factors:• Market penetration trends .• Price changes.• New product

introductions.• Sales channel innovations.• Government regulations.• Weather.

Additional factors:• Market penetration trends .• Price changes.• New product

introductions.• Sales channel innovations.• Government regulations.• Weather.

Sales ForecastSales Forecast


Constructing a Custom Market IndexConstructing a Custom Market Index

• Company SalesCompany Sales• Total company

• By group

• By division

• By product line or product groups

The market index links company sales with measures of business activity in its key markets:

Business Activity MeasuresBusiness Activity Measures• Industrial production.

• Employment

• Business equipment investment

• Construction investment

Key MarketsKey Markets• By country.

• By region.

• By industry.

• By sales territory.


Market Index 1: Well-Defined Market Market Index 1: Well-Defined Market Information AvailableInformation Available

Market Segment

1998 Sales Distribution

Driver Variable

Automotive 54.9% Unit Auto Production

Office Equipment 7.7% IP-Office Machines/Computers

Distribution 6.2%

Other Transportation 5.5% IP-Trucks/Tractor Trailers

Electrical Equipment 4.5% IP-Electrical Machinery

Power Equipment 4.3% IP-Nonelectrical Machinery

Construction 4.3% Real Construction Investment

Appliance 4.2% IP-Household Appliances

Fabricated Metal Products 3.3% IP-Fabricated Metal Products

Non-Auto Engines & Components 1.2% IP-Engines & Turbines

Miscellaneous 3.9%


Market Index 1: AlgebraMarket Index 1: Algebra

MI1(real) = 0.549*(unit auto prod.)/(unit auto prod. in 1998) + 0.077*(IP-office machines)/(office machines in 1998) + 0.055*(IP-trucks/trailers)/(IP-trucks/trailers in 1998) + 0.045*(IP-elect. Mach.)/(IP-elect. mach. in 1998) + 0.043*(IP-nonelect. mach.)/(IP-nonelect. Mach. in 1998) + 0.043*(Real const. inv.)/(Real const. inv. in 1998) + 0.042*(IP-appliances)/(IP-appliances in 1998) + 0.033*(IP-fab. metal prod.)/(IP-fab. metal prod. in 1998) + 0.012*(IP-eng. & turb.)/(IP-eng. & turb.)

MI1(nominal) = MI1(real)*(PPI-fasteners)


Market Index 1 vs. Historical SalesMarket Index 1 vs. Historical Sales

0

0.5

1

1.5

2

2.5

3

3.51

98

7

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

Ind

ex

19

87

= 1

.0

Penetration GainClient SalesClient Market Index

Actual sales growth exceeded that of the market index.

Three periods of interest: •1988-89.•1992-93.•1995-98.


What We’ve Learned—Market Index 1What We’ve Learned—Market Index 1

• When markets are well-defined, the market index usually can be also.When markets are well-defined, the market index usually can be also.

• Building the market index should be a consensus-building effort. Building the market index should be a consensus-building effort. • This is a great way to encourage model buy-in by key executives.

• IP Index levels work well in defining a market index for products that are IP Index levels work well in defining a market index for products that are materials and supplies to the production process.materials and supplies to the production process.

• It is often not necessary to worry about undefined end markets (distributor It is often not necessary to worry about undefined end markets (distributor sales or “miscellaneous” sales). sales or “miscellaneous” sales). • Often, these have an end-market distribution similar to the known end-

markets.

• However, acquisitions need to be taken into account.However, acquisitions need to be taken into account.

• Be sure to match nominal sales with a nominal-valued market index; ditto Be sure to match nominal sales with a nominal-valued market index; ditto for unit sales and a constant-$ valued index. for unit sales and a constant-$ valued index.

• Confirm deviations between company sales and the market index.Confirm deviations between company sales and the market index.• Be sure the market index is not misspecified.

• Become comfortable with the rationale for the deviations.

• This process also contributes to model buy-in.


Market Index 2 (Dupont)—Imprecise Market Index 2 (Dupont)—Imprecise Sales Distribution Data Sales Distribution Data

Vehicles Chems. Textiles Life Sci. Paper Etc

AN .1 .15 .3 0 .1 AR .15 .11 .26 .02 .03 BZ .15 .11 .26 .02 .03 CA .1 .05 .21 .05 .05 CH .1 .25 .1 .3 .05 EE .15 .09 .23 .09 .16 FR .15 .09 .23 .09 .16 GF .15 .09 .23 .09 .16 HK .1 .25 .1 .3 .05 ID .1 .15 .15 .25 .05 IN .2 .2 .1 .25 .05 IT .15 .09 .23 .09 .16 JA .15 .1 .12 .25 .05 KO .2 .25 .05 .28 .02 Etc.

• A global market index requires many more A global market index requires many more terms.terms.

• Global Insight’s World Industry Service, Global Insight’s World Industry Service, which tracks industrial activity across which tracks industrial activity across country, provided the drivers for this market country, provided the drivers for this market index. index.

• The index weights for this index were The index weights for this index were representational, based on management’s representational, based on management’s judgment. judgment. • Experienced, senior management often

have a good feel for the proper weightings.

• Alternative weighting schemes can be tested by constructing a sales-market index chart like that for Market Index 1.


Market Index 2 vs. Historical and Market Index 2 vs. Historical and Future SalesFuture Sales

020100999897969594939291908988878685848382

12

10

8

6

4

2

0

-2

-4

-6

-8

-10

-12

%

DUPONT MARKET INDEX -- WORLD

ANNUAL GROWTHACTUAL FCST

MARKET INDEXSALES VOLUME

• The Dupont Market Index The Dupont Market Index performs very nicely over a performs very nicely over a long test period.long test period.

• It also tracked well in the It also tracked well in the forecast period for 2001-02. forecast period for 2001-02.

• Additional Lessons:Additional Lessons:• Even with less-specific

sales distribution data, it is possible to construct a valuable market index.

• Global market indexes can be complicated by the need to adjust for exchange rate shifts.


Market Index 3—Capital Equipment Market Index 3—Capital Equipment

• Capital equipment often present a special challenge in constructing a Capital equipment often present a special challenge in constructing a market index.market index.• Volatility is a hallmark of capital goods sales.

• Sales of capital goods tend to be “lumpy.”

• Market Index 3 is inspired by work we did for a manufacturer of Market Index 3 is inspired by work we did for a manufacturer of industrial air compressor equipment. industrial air compressor equipment. • We examined a variety of potential market indexes, but ultimately

found that manufacturing industrial production worked very well.

• Aggregate industrial production is itself a weighted market index.

• But, industry sales of air compressor equipment was far more volatile than manufacturing-sector industrial production.

• Economic theory suggests that capital equipment sales are more closely linked to the change in the market drivers, and we used this approach to refine the market index.


Market Index 3-Level vs. Historical Market Index 3-Level vs. Historical SalesSales

0.6

0.8

1.0

1.2

1.4

1.6

1.8

1988 1990 1992 1994 1996 1998 2000 2002

Index of Real Air Compressor Equipment SalesManufacturing Industrial Prod Index

• As anticipated, manufacturing-As anticipated, manufacturing-sector industrial production is sector industrial production is “sorta” correlated with sales of “sorta” correlated with sales of industry air compressor industry air compressor equipment. equipment.

• But industry sales are much But industry sales are much more volatile than industrial more volatile than industrial production, both on the upside production, both on the upside and the downside. and the downside.


Market Index 3-% Chg vs. Historical SalesMarket Index 3-% Chg vs. Historical Sales

• As economic theory suggests, As economic theory suggests, industry sales are more correlated industry sales are more correlated with the with the changechange in manufacturing- in manufacturing-sector industrial production. sector industrial production. • The volatility is now similar.

• But the timing is a bit off in 1997-98 when real air compressor sales lag behind the peak in industrial production % change.

• Similarly, the market index is misleading in 1992-95.

0.6

0.8

1.0

1.2

1.4

1.6

1.8

-.04

-.02

.00

.02

.04

.06

.08

1988 1990 1992 1994 1996 1998 2000 2002

Index of Real Air Compressor Equipment Sales% Chg in Manufacturing Industrial Production Index


Market Index 3-% Chg vs. Historical Market Index 3-% Chg vs. Historical SalesSales

• Smoothing the market index by first Smoothing the market index by first constructing a 3-year moving average constructing a 3-year moving average of it, then taking the % change of it, then taking the % change enhances its correlation with real air enhances its correlation with real air compressor sales.compressor sales.• Over 90% of the variation in real air

compressor sales is explained by this version of the market index.

• The index misleads in only three The index misleads in only three years, and the client already years, and the client already understood the reason for 1996.understood the reason for 1996.

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

-.01

.00

.01

.02

.03

.04

.05

.06

1988 1990 1992 1994 1996 1998 2000 2002

Index of Real Air Compressor Equipment Sales% Chg in 3-Year Movav of Mfg IP


Data Sources for Building Market IndexesData Sources for Building Market Indexes

• Global Insight.Global Insight.

• Bureau of the Census (wholesale and retail trade, housing, Bureau of the Census (wholesale and retail trade, housing, population, trade).population, trade).

• Bureau of Economic Analysis (GDP, income, profits, Bureau of Economic Analysis (GDP, income, profits, government expenditures, compensation, inventories).government expenditures, compensation, inventories).

• Bureau of Labor Statistics (employment, wages, prices).Bureau of Labor Statistics (employment, wages, prices).

• Federal Reserve (industrial production) .Federal Reserve (industrial production) .

Today, all the federal government data is readily available through the web, Global Insight, or other private data

vendors.

Documents

Practical Goal-Setting: Benchmarking and Forecasting your Industry End Markets Presented at the Economic, Industry and Consumer Outlook Seminar April 29,