The popular ‘Desert Island Discs’ programme asks famous people to nominate the CDs they would take with them to provide solace if they were unfortunate enough to be shipwrecked on a desert island. It got me thinking about what software and tools I would want by my side if my company was stranded and surrounded by the choppy waters of recession.
I suppose that most businesses would reach for Microsoft Excel, after all the trusty spreadsheet has stood the test of time and remained the number one tool of choice for finance functions in almost every part of the world. In fact the desert island setting for a personal productivity tool is most apt – one could model to one’s heart’s content without any sign of interference or dissent.
But I wonder if spreadsheets may contribute to more problems than they solve. Rumours are rife that City institutions are now baffled by some of the complex financial instruments and derivatives whose secrets lie bound up in unfathomable and undocumented spreadsheets macros.
The problem with spreadsheets is that left unguarded and in the hands of the enthusiast, the ubiquitous worksheet takes on a life of its own, transitioning from a tool designed to support personal productivity into a full scale application on which businesses can become over reliant.
In management information terms the spreadsheet poses even more significant risks. Cut off from underlying operational systems the spreadsheet becomes of dubious reliability. Manual data transfers, the unfettered ability to change the meaning of account lines, overwrite macros, data and formulae introduces a whole range of risks that cast doubt on the reliability of anything produced in a spreadsheet. If I was trying to steer my company out of recession I wouldn’t be looking at a spreadsheet to give me inspiration and guidance.
Yet management information is the key. Without accurate insight into current and projected performance on which to take decisions there is no chance of leaving our virtual desert Island. So if the spreadsheet doesn’t do it, what tool(s) would?
Recent research shows that in the downturn companies are turning in force to their forecasting systems. In a very positive development businesses that previously budgeted performance merely once a year are now producing forecasts every quarter and refreshing their projections monthly. The one thing that companies need to do in a downturn is to take the temperature of the water regularly and frequently, monitoring key performance indicators, looking for tell-tale clues that indicate the start of a trend or a shift in customer behaviour.
Intel last week demonstrated just that. In an interview on CNN Money, the chip maker’s CFO pointed to a changed pattern in demand at the end of the quarter – just enough to indictae that PC makers had run down their inventories and that the market could be turning more positive. However, when it came to timing, i.e. calling the point at which low inventories would tip into fresh demand the answer was less certain. It seemed like large enterprises were reluctant to put their hands in their pockets to spend on PC’s and Intel seemed to be pinning its hopes on the consumer in the short term. But it illustrated the problem with forecasting – where were the leading indicators or KPIs that would suggest whether orders would pick up? How sophisticated is Intel’s model? Had they fully assessed all of the likely (and improbable) scenarios?
So what tools can help? The ideal tool is the proverbial crystal ball and funnily enough there is a predictive analytical tool called Oracle Crystal Ball, a part of Oracle’s performance management suite. It is a new generation application that allows businesses to model likely performance.
Most businesses are familiar with the relationship between risk and reward but in assessing potential opportunities rarely acknowledge risks and probability in a formal way. That is not to say that there is not a role for intuition and experience, it is just that the record shows that businesses which regularly perform scenario planning and sensitivity analysis produce more accurate forecasts.
Even then, sensitivity analysis tends to be a limited exercise concentrating merely on three common scenarios, “best case”, “worse case” and something “in between”. Usually, worked up in a spreadsheet these scenarios tend to flex one or two variables (assumptions) at a time and provide little insight into probable outcomes which in the real world reflect the collective influence of many variables (good and bad) impacting at the same time. Is there a better way?
Oracle Crystal Ball makes use of Monte Carlo simulation to refine forecasts and set realistic expectations about the range of possible outcomes. It works by modelling a number of business assumptions in parallel which each have an assigned range of input values and probabilities. For example, a house builder may decide to model “House Sales” based on assumptions about interest rates, inflation, and unemployment, setting for each of these variables the range of likely values and their probability. Monte Carlo simulation then uses random number generators in combination with various mathematical probability density functions to generate thousands of scenarios.
By summing the scenarios, the simulation provides a forecast of the results expected from integrating the interactions of all of selected variables (interest rates, inflation, and unemployment in this case – but it could be more), presenting the probability of achieving each of the builder’s desired levels of “House Sales”. Furthermore, models of this type can identify the most influential (sensitive) factors to take into account. For example, bad news on unemployment may in the majority of cases outweigh any other considerations and management can focus on this as the key determinant in deciding whether or not to turn its land bank into new builds.
Which takes me back to my barren desert island. There is no point looking back at how one became stranded - the only sensible route is to plan the way forward. If I had the choice between a crystal ball and a spreadsheet the former gets my vote.
