Entrepreneurial Leadership and Management . . . and Other Stuff

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30
Jun

Just Say No To Weighted Average Sales Forecasting

Any reasonable direct selling process involves establishing a specific set of milestones to help track how far along a prospect is on the path to making a purchase.  These usually include one or more of the following steps:

  • Lead found/created
  • Opportunity qualified
  • Prospect visited/contacted
  • Product demonstrated/Eval in the hands of the prospect
  • Follow-up contact
  • Product selected
  • Prospect has requisite financial approvals
  • Paperwork completed
  • Prospect invoiced
  • PO/cash in hand

Of course, these steps are specific to what is being sold and what process is used, but steps similar to these can be readily mapped to most direct sales processes.  In my view, keeping accurate track of where a prospect is using a tracking process like this, or with milestones that better suit your business, is absolutely critical.  Tracking the process with detail is very important for new companies because gathering data about how the product is sold and adopted is critical to future planning and to adjusting the business moving forward.  As your business matures, using such a process helps you characterise your sales efforts further, ultimately giving you a more accurate means for predicting your bookings, revenue and cash flow.

It’s easy, though, for this data to be misused or overused.  I often see sales organizations map these steps into percentages like this, below, where the right column represents the percentage of completion of the sale.

Lead found/created 5%
Opportunity qualified 15%
Prospect visited/contacted 20%
Product demonstrated/Eval in the hands of the prospect 40%
Follow-up contact 60%
Product selected 70%
Prospect has requisite financial approvals 80%
Paperwork completed 90%
Prospect invoiced 95%
PO/cash in hand 100%

On a superficial level, there’s nothing wrong with this.  It simplifies where the company is in the process of closing a sale by mapping the sales progress to a single number that everyone can understand.  “We’re 80% along the way to closing a deal with customer”  is much easier to understand than, “customer X has his internal financial approvals so we should close soon.”

The problem is that sometimes this simple number morphs into something that it wasn’t intended to be – the probability that the deal will close.  80% along the path to closing is different than having an 80% chance of closing.  Even worse, the percentage of completion of the sales process is often used to mathematically calculate the likely booking amount for a particular deal.  Say, for example, a prospect has selected your product as the one he/she wants and is getting ready to invest $50K.  With the mapping above, you might say that the prospect is 70% along the path to closing.  Through the magic of weighted average forecasting you would take the percentage of the sales stage, multiply it by the $50K the prospect is willing to spend and come up with a $35K forecast for that prospect ($50K X 70%).

When stated this way, it sounds absurd that anyone would do this, but it’s done all the time.  I frequently sit in board meetings where the Sales VP presents a list of potential customers, their sales stage percentage (from a table similar to that above), the projected bookings from a sale to a particular prospect and a forecast that is the result of multiplying the sales stage percentage by the projected bookings.  These numbers are them summed to come up with the quarterly forecast.

Among the myriad of problems that this process presents is that sales just don’t work this way.  They are far more binary-like events than the stages of the sales process would indicate.  Even at the 80% level, there is fallout.  One deal falling out at the 80% level can invalidate the entire forecast, depending on its size.  Just as likely, a deal at 20% can come in quickly, similarly invalidating the forecast.  Since forecast accuracy is critical, especially in small companies, using a weighted average forecasting methodology is fundamentally flawed.

There are simply too many factors involved to accurately boil down sales forecasting into simple equations.  A good, experienced sales person has a gut feel for where a prospect is and the likelihood that he/she will make a buying decision in a given period of time.  While a sales stage percentage is a reasonable benchmark for where a prospect stands and is an absolutely critical tool for junior sales people, it is not nearly accurate enough to base the progress of a company on. 

Sales people need to be close to their prospects, knowing who the key decision-makers are with a thorough understanding of the purchasing process in the account.  Once they have this, they will be able to estimate what deals will come in for how much during any given period with far more accuracy than a simple weighted averaging forecasting tool does.  As always, good management and loads of wisdom trump virtually any tool that can be created.

 June 30th, 2006  
 Will  
 Management, Selling  
   
 15 Comments
05
Apr

Forecast Accuracy

Inevitably, after each fiscal quarter, a couple (or few, or many, or most) of the companies I work with inform me that their sales results for the quarter were below expectations. By itself, of course, this is usually not a catastrophe (although it sometimes can be) and leads to some reflection about what went wrong. What drives me completely nuts, though, is when numbers are missed after the company had been forecasting higher numbers during the quarter. I go total berserk when those higher numbers were still being forecast late in the quarter – sometimes until the last day. It’s not only when numbers miss on the low side that makes me upset. Sometimes, even when numbers miss on the high side I find cause for concern.

To me, forecasting accuracy is the single most important measure of the quality of a sales team. And, thus, is a reflection of the CEO’s ability to manage the sales process and sales team.

Being able to accurately predict bookings and, more importantly, collections in a small business is absolutely critical to maximizing a company’s opportunities and growth. The more accurate the prediction of income, the better spending can be aligned and the more efficiently the capital gained from the sale of equity or absorption of debt can be utilized. Why sell more of the company or take on more debt than is needed?

Aside from the financial issues, there are very few things that can hurt morale in a company more than missing a couple of quarters back-to-back. It’s quickly seen as a sign of weakness in the product, company or market and makes employees question what they are doing and how many hours of their lives they are pouring into the enterprise. Doing what you say you’re going to do, and sometimes doing better, makes everyone feel like they’re dedicating their efforts to a worthy cause.

Companies have sales plans, of course, which are generally set up a year ahead of time. A year is a very long time for a small company and accurately establishing sales predictions that far ahead of time is virtually impossible to do correctly. Forecasting, on the other hand, while often done for longer periods, generally is studied for the current or next quarter. This shorter term look at sales should be far more accurate than the longer term sales plan.

Forecasting for small companies without much of a pipeline is difficult. In this case, if a deal drops out of the forecast, it’s not likely to be replaced by another deal that comes in ahead of schedule. When companies are small, closing those all-important first key deals should be the main focus of the sales force. After those initial deals are closed, however, the focus should change to increasing the size of the pipeline in order to create a stable and predictable revenue/bookings/cash stream.

There is no excuse for a company with an established sales team (direct or indirect) to miss the numbers it predicted just a couple of months earlier by any significant amount. This means high or low. If the numbers are high (not including bluebird deals that were never in the pipeline), then spending wasn’t optimized and growth through increased spending could happen sooner. If the miss is low, then the company potentially spent more than it should have and may run into cash problems earlier than planned.

There should be enough visibility into the deals in the pipeline and enough of an understanding of the sales cycle to be able to determine which deals are going to come in during a quarter and which deals aren’t. Certainly, as the company gets further into its quarter, the more accurate the forecast for that quarter should become. With this logic, one should assume that the forecast one week before the end of the quarter should be basically right on. It’s shocking to me how often that it’s not.

The CEO and VP Sales need to be held responsible for the accuracy of the forecast. In my experience, they are often either judged on their sales achievement with respect to their plan only or, even more often, with respect to some abstract level of sales that seems right for the maturity of the company in its particular market. This is not sufficient. Accuracy of forecast is an indication of how close the CEO and Sales VP monitor the pulse of the business. It demonstrates how well the two understand the customer, the sales cycle and the market. Without a detailed understanding of these, there is little chance that the company will be successful. Therefore, it needs to be one of the key and, at certain stages of the company, the primary key factor in judging the success of company management.

The way to make this work, of course, is through compensation plans, making sure the company is tracking the right metrics and always asking good questions. I’ll talk about some of this stuff in the future in a post about compensation plans and unintended consequences.

 April 5th, 2006  
 Will  
 Management, Selling  
   
 11 Comments