Attention Demand Planners, wouldn’t you AND your CFO both like to know how much profit your current forecast is leaving on his table? Turns out you can; all that’s required is getting a second opinion of your current forecast just like you would if you had an important medical condition. Or, another way to think about it might be as an analytic consultation of your forecast.
How Does The Second Opinion Forecast Work?
First, a bit of background is in order. As is well understood, the most important element in developing next year’s plan is the forecast. This forecast is “translated” into next year’s profit by subtracting the income statements’ various costs from the forecast’s revenue; specifically, cost of goods sold and sales & marketing, general and administrative costs. These costs come from the budget. Thus, the forecast in concert with the budget determines for the CFO next year’s planned profit.
The Second Opinion Forecast has no dependence on next year’s budget.
The Second Opinion Forecast (SOF) is developed entirely differently; it has NO dependence on next year’s budget. This fact should please your CFO given the current budget’s widely recognized limitations, including short life-span, how time-consuming it is, and how rapidly its assumptions are outdated.
Rather, SOF accomplishes this independence from the budget by building a model of the income statement, an Operational Income Statement (OIS). This model integrates two analytic techniques in widespread use today. The first is Supply Chain network design and the second is demand-sensing modeling (often referred to as marketing-mix modeling).
How To Create An SOF Model
There are three steps involved in creating an SOF model:
Step 1: Working closely with the CFO’s management accountants within FP&A, a model is built from last year’s income statement (i.e. profit and loss) in Supply Chain network design software. This model, the baseline, ensures the model has structural integrity, typically modeling last year’s results to within 1-2%. However, this model differs from network design efforts because its planning horizon is only a year and it includes SG&A costs.
Step 2: This model is then updated with next year’s planning data including:
- Replacing the sales/marketing costs in the baseline model with demand sensing functions which describe how the forecast volumes vary as a function of sales and marketing expenditures
- Reflecting any and all improvements planned for the Supply Chain in the coming year including changes in sourcing, process improvements, in/outsourcing decisions, new production lines, plant facilities, etc.
Step 3: This updated baseline model then selects the Sales & Marketing expenditures which create the most profitable forecast using the demand sensing functions. This demand-sensed forecast is the SOF forecast.
Second Opinion Forecasting allows the income statement to be updated much more quickly and accurately during the year.
Why Is The SOF Important?
The SOF allows the CFO to compliment the current financially-based enterprise planning efforts with the same planning foundation that the Supply Chain currently uses, i.e. Operations. As described below, the benefits the SOF provides for the enterprise in general and the Demand Planners in particular, are significant.
There are a variety of benefits including:
- Creation of a new maximally profitable demand-sensed forecast, the SOF
- The SOF model configures the best Supply Chain required to make and fulfil the SOF, respecting all the Supply Chain’s constraints including sustainability (e.g., energy consumption, carbon emissions
- It allows the income statement to be updated much more quickly and accurately during the year
- It improves the forecast process’s profit results going forward
- It maximizes the return on investment of sales and marketing expenses
- It fulfils a long-held belief amongst Demand Planning experts that Demand Planning is held back by being purely a Supply Chain-focused function. There’s no real reason it should be limited to Supply Chain.