Improving financial predictability – is it chasing a mirage? By Prakash Arunkundrum, PwC Strategy and Operations Consulting Director There is continued evidence that despite spending several millions on IT transformations, improving internal planning processes, maturing supply chains, and streamlining product development processes- several companies still struggle with predicting their financial and operational performance. Don’t think so? Take a look at the PwC analysis on earnings surprises for 2012-2013 – many companies were poor at predicting revenue one quarter out, and the guidance on certain metrics such as gross margins and OpEx were poorer. Some attribute these results to fast product lifecycles, behavioral factors (i.e., sandbagging to exceed performance), market volatility, or a host of other external factors. I contend that these results can also be explained by many internal factors, such as how a company approaches planning and how seriously they value predictability. At PwC, we benchmark operational performance of high-tech and semiconductor manufacturers on a regular basis. Recently, we have noticed that the median forecast accuracy of technology companies from 2009 to 2013 has dropped over 500 basis points! This doesn’t correlate with the belief within many companies that they are getting better with their planning processes. So what are we missing? While companies have improved their operational planning processes, disconnects to the broader financial planning and reporting processes have remained and in some cases, worsened due to the faster clock speed of product introductions. As I’ve stated previously, there are several reasons behind “surprises.” Below is the common classification of earning surprises and note that several of them are due to planning challenges. When examining this across several companies, there are five core reasons behind the planning disconnects: Limited understanding of true market rate of demand – Historical projections to develop a financial plan are disconnected from unconstrained sales forecasts; Post-close bridge analysis explain deltas but don’t drive improved forecast methods Immature end-to-end S&OP processes – Slow open-loop supply planning and partner collaboration processes Disconnects between S&OP, Product Planning and Financial planning process – Forecasts have insufficient operational input and incentives are not always aligned Budget allocations do not always reflect latest sales, product, and operational pulse – Process lacks leading indicators and transparency Inability to make rapid cross-functional decisions based on data and simulation models reflecting changing business environment Often the costs of inaccuracy are not immediately felt, lulling companies into deprioritizing the impact of poor planning. Left unaddressed, planning challenges impact predictability, and can also impact business performance. A few real-life anecdotes behind some of our client engagements on planning topics include: “… Why does my S&OP plan call for higher inventory levels than the financial plan (which was provided as street guidance)? The S&OP plan called for higher revenue attainment and on-time performance, but finance never factored the cost to support revenue “ – High-tech COO “Despite all the IT investments, I just missed my quarterly gross margin target by a mile”- Manufacturing OEM CFO “We are really good at hitting our dollar revenue forecast but continue to watch with baited breath if we will make the quarterly budget targets till the last day of quarter” – Semiconductor VP of Finance “We have no idea how many buffers are placed on the demand plan and by whom – leading to mistrust on the real demand internally and with partners” – Semiconductor VP of Operations The answer: Step closer toward “Integrated Planning” With experience helping clients improve financial efficiency and performance from our PwC legacy service offerings and in operations from recent acquisitions such as PRTM, Diamond and Booz & Co, we have found that the following key areas are critical steps toward improving your planning process: 1. Process: Balance and align S&OP and Finance goals to create a consensus plan by: Separating forecasting from demand planning – Establish a demand planning discipline and analytics driven capability as a neutral function that drives consensus across sales, product marketing, operations and finance Orchestrating the financial, product, and operations planning activities across products, geographies, and functions on a unified cadence Linking planned incentives to planned performance and corporate goals instead of budgets and functional goals 2. Data: Align product data structure across all functions while establishing an integrated operational data model for common definitions and usage 3. People: Minimize organizational silos and align incentives – Clearly defined accountability for execution and adherence to outcomes of the decision making forums 4. Technology: Create an end-to-end planning simulation system that supports both S&OP planning and financial planning activities – Unified simulation model across all functions with ability to understand impact of changes directly on the key elements of the P&L and balance sheet The Integrated Planning environment—with integrated process, data, organization, and technology capabilities—will allow finance and operations teams to work closely and strategically, ultimately enabling companies to accurately forecast earnings and respond with agility. While these steps sound ambitious and daunting, I recommend key stakeholders start by stepping back to assess their current end-to-end planning process to begin their Integrated Planning journey.