A big breakthrough for early 20th century businesses? Forecasting demand

A big breakthrough for early 20th century businesses? Forecasting demandIt might seem obvious that, to build a compelling business strategy, you need foresight. You need to understand where market forces are pushing you. In Wayne Gretzky’s words, you “need to skate where the puck is going to be, not where it has been.”

This observation wasn’t always obvious. In fact, the idea of using forecasted demand to make business decisions is only about 100 years old. 

Forecasting demand was a real achievement 100 years ago

Alfred D. Chandler published his book Strategy and Structure in 1962. He wrote case studies of four large American businesses: DuPont, General Motors, Standard Oil of New Jersey, and Sears, Roebuck. He described how executives restructured these companies, based on the strategy they pursued. 

Here is what Mr. Chandler had to say about the importance of forecasting demand (page 293):

Thus, in all four of these companies, and certainly also in a great many other American industrial enterprises, tactical and strategic decisions and operational and entrepreneurial activities came to be based on data dealing with anticipated market and economic conditions as well as those concerned with past and current performance. The development of increasingly accurate and precise information for the use of the senior executives in planning, coordinating, and appraising the activities of an enterprise as a whole was a major achievement of the American organization builders.

The last sentence highlights an interesting observation from Strategy and Structure. What seems obvious to you and me now, simply wasn’t so in the early 20th century. And business today relies heavily on conventional wisdom that isn’t that old.

What kind of things did business struggle to predict, 100 or so years ago?

  • The excess manufacturing capacity that emerged at the end of World War I. DuPont quickly ramped up its gun powder and explosives manufacturing during the war. After the war, demand plummeted. DuPont had to scramble to make new use of its capacity.
  • The steep falloff in automobile demand, resulting from the depression of 1920–1921. General Motors continued to build inventory as though the post World War I boom years would continue. The situation got so bad that, according to Mr. Chandler, “…many General Motors managers were having difficulty finding cash to cover such immediate needs as invoices and payrolls.” (page 129)
  • A milder falloff in the demand for automobiles, crude oil, and refined products, resulting from an economic slowdown in 1924. General Motors’ annual sales fell by 20% and Standard Oil of New Jersey’s deliveries fell by 10%, year over year.
  • A prolonged drop in oil prices, due to the glut in oil production beginning in 1926. Standard Oil reconfigured its business in part to manage the oversupply problem.
  • The Great Depression, which caused a severe sales contraction at Sears in the early 1930s. Even without the depression, Sears was struggling under the weight of organizational inefficiency. Given the bleak economy, the company quickly reorganized, in part to reduce costs.

It feels safer to not make any prediction at all

Now, we come to the question…were these events predictable? It’s difficult to know in hindsight. I’m sure some people would have claimed to predict one or more of them.

But that’s not the point. The point is that businesses failed to look forward with any type of rigor. In most cases, these businesses invested simply by looking in the rear view mirror. We sold 10,000 cars last year? Let’s ramp up production to 11,000 this year.

Again, it seems obvious that you would look forward and try to predict demand. The problem is it’s difficult to do that. And no matter what you predict, you’ll be wrong. Economic systems are too complex. There’s no way to know with certainty how the various pieces will fit together over time.

The fear of forecasting is rooted in the human condition…the fear of being wrong. People would rather not make a call at all, than make a public call and risk looking foolish. It’s easier to explain a miss by saying “Well, I expected historical trends to continue” rather than “Well, I expected things to change, and they didn’t”. It’s a natural play toward risk aversion.

That’s why forecasting demand may seem obvious now, but it wasn’t 100 or so years ago. It took some time to learn the very painful lessons of what can happen if you always assume the future will look like the past. DuPont and General Motors hemorrhaged cash for that very reason. Then they forced themselves to rigorously examine the status quo and make projections for the future.

Making informed predictions is a key element of good strategy

Richard Rumelt, in his 2011 book Good Strategy Bad Strategy, also highlights the importance of forecasting demand (page 98):

The strategist may have insight into predictable aspects of others’ behavior that can be turned to advantage. At the simplest level, a strategy of investing in Manhattan real estate is based on the anticipation that other people’s future demand for this real estate will raise its value. In competitive strategy, the key anticipations are often of buyer demand and competitive reactions.

We all know how difficult it is to design a robust, compelling strategy. Most businesses fail miserably at strategy. And one of the challenges is the inability, or unwillingness, to forecast demand.

It’s not the specific projection that matters. It’s not important whether we think sales will grow by 5% or 10%. What’s important is that we have a rigorous market analysis that informs our expectations.

No projection will be correct. You won’t call the next recession. You won’t foresee the next time the government cancels a lucrative contract. But you can acknowledge the risks. You can admit when tailwinds are weakening, or when headwinds are strengthening.

Even a directional understanding of how important market forces will change can be incredibly valuable. Do you expect transportation services like Uber to drive down future demand for automobiles? Do you expect local solar power generation to increasingly lighten the load on our existing electrical grid? Do you expect future combat to be executed more by unmanned drones, reducing the need for human soldiers and any gear those soldiers might need?

These trends might impact the demand for your products or services. While you might be right about the trend, you’ll probably be wrong about the intersection of (a) the magnitude and (b) the timing. That’s okay. Being aware of the risks posed by ongoing trends to your business is helpful in and of itself.

It’s easy to ignore the importance of building forecasts

Forecasting demand seems like an obvious thing to do. Surprisingly, some of America’s largest businesses had to learn the value of forecasting in very painful ways. For us, the lesson is to appreciate the value of forecasting. It seems mundane, and at times fruitless, since we know we’ll be wrong.

The real value isn’t in the accuracy of the forecast. The real value is in having thought with discipline about the future. Acknowledge that the future might not look like the past. The further we can push ourselves in this uncomfortable direction, the better business decisions we’ll make.

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