Recently in one of Justin Roff-Marsh’s SPE Practitioner Tips (which you can subscribe to here), he asserted that salespeople and their managers spend too much time trying to forecast sales revenue.
Most sales groups forecast revenue by adding the value of all opportunities and then adjusting them for risk. To make the adjustment, they assign a probability that each deal in their pipeline will close, multiply the product of the probability and the deal size, and add them all together.
The calculations look something like this:
Credit: Justin Roff-Marsh
This statistical method of forecasting is inherently unreliable because the sales group has combined uncertain risk-adjustments with small sample sizes.
Roff-Marsh identifies the main problem with this method. The risk adjustments are nearly always a guess. They are often manipulated to achieve a forecast that will satisfy sales management.
Even though the sales forecast is unreliable and requires a lot of time to estimate, sales teams are under pressure to produce this number month after month. Why is that?
Executives, financial planners, and production planners all want to see an estimate of future revenue. They naturally ask sales to provide this estimate to them.
There is a further reason that sales teams use this method to forecast revenue. They are chronically starved for good sales opportunities, so they scrutinize every deal for its potential to convert. If they had a bigger pipeline then each single deal would not have to be scrutinized so closely.
The consequence: The whole company needs an accurate revenue forecast, but sales uses an unreliable method. This approach to sales forecasting leaves the company unable to accurately plan for its production and financial needs.
Roff-Marsh suggests a different approach. His method uses scenario planning instead of statistics.
The Scenario Planning Method for Sales Forecasting
In his approach, Roff-Marsh coaches salespeople to do several things differently:
- They carefully align each deal with the pipeline stage that reflects objective observations of customer behavior.
- Instead of building a forecast based on all deals in the pipeline, they ignore early stage opportunities and focus only on late stage opportunities. By restricting themselves to late stage opportunities, they have less need to assign a probability to the deal because these are all high-probability opportunities.
- The scenario planners review the late stage opportunities and assign them to one of three categories: possible, probable, and highly likely.
- Next they assign each deal to the month in which it is expected to close and they give each deal a dollar amount.
- With this knowledge the team can produce three month-by-month scenarios for business that is highly likely, probable, and possible to close.
Visually this can be presented in a chart like Roff-Marsh’s chart below. This chart conveys a lot of information because it’s limited to late-stage deals which have been broken out month-by-month into three scenarios.
Credit: Justin Roff-Marsh
The Conflict Between Sales Forecasters and Scenario Planners
Although some of his clients use the scenario-planning method for forecasting, the Roff-Marsh solution would create conflict in organizations that currently use conventional sales forecasts to plan for future revenue.
While it’s true that those who support conventional sales forecasting and those who advocate for a scenario-planning method would agree on the same goal, the need to plan for future revenue, they would disagree strongly on how to achieve the goal.
The sales forecasters would say that they need to give management a forecast that it can incorporate into their planning systems in order to forecast future revenue. Further, to give management a forecast, they must provide a single number that can be entered into the planning system. The way they arrive at a single number is by calculating the risk-adjusted aggregate estimate of future revenue from all salespeople.
On the other hand, the scenario planners would say that they must give management a truthful forecast of an unknown future in order to plan for future revenue. Further, to give management a full picture of a truthful forecast, they must produce multiple scenarios of the future.
These two approaches to achieving the same end, the ability to plan for future revenue, are in direct conflict. One approach forecasts revenue based on calculating a single risk-adjusted number and the second forecasts revenue based on a set of scenarios. A company can’t do both simultaneously.
Is there any way to resolve this conflict? To do so, we have to look at the assumptions that each side makes and see if any of them are faulty. If they are, then we might be able to inject an alternative way of working that resolves the conflict.
Questioning Our Assumptions
Let’s look at the assumptions that each group makes and see if any of them can be called into question.
The sales forecasters want to forecast a number that they can incorporate into their planning system. The plans for production, financing and staffing all depend on the revenue forecast. Further, they use the planning system to report to the Board and shareholders.
Sales is the only group that can supply information about customer purchasing plans. However, they could supply this information in many ways. It doesn’t have to be a single forecast number (especially if we suspect the accuracy of the number).
Next we’ll look at the scenario planners. What assumptions do they make?
The scenario planners want to give management a truthful forecast to plan for future revenue because many other plans are dependent on the truth of the forecast. If the forecast is too optimistic or too pessimistic or simply doesn’t convey the range of possible outcomes, financial planners and production planners will make significant errors.
The scenario planners make the assumption that it’s better to illustrate the uncertainty in the forecast rather than hide this uncertainty and possibly mislead planners and management.
They base their forecast only on late stage opportunities and they believe management should see a range of potential scenarios. They also believe that we should increase the size of the pipeline so that sales is no longer chronically starved for opportunities. A bigger pipeline would make it no longer necessary to place so much emphasis on each deal and its probability of closing.
A. Sales needs to be the one that forecasts revenue, but it doesn’t have to be a single number in order for the forecast to be useful.
B. Sales does not have enough information to estimate the probability of deals closing. The only thing they can do with confidence is take the late stage deals and break them out qualitatively into three buckets.
C. Executives and planners need forecast accuracy more than they need a single number. By giving them a range of scenarios, they can combine this knowledge with other information and make their own estimate of the forecast. This method lets sales provide a richer set of useful information to the planners and it does not force sales to make impossible predictions.