"A great deal of uncertainty exists in the global economy, making it extremely difficult to know how our customers will respond during the remainder of 2009."
Where have we heard this line before? In this case, it was Caterpillar CEO James Owens, a former CFO and economist, explaining in April why the company cut annual profit estimates in half as it reported its first loss in 16 years. But Owens is hardly alone. Executives at companies from wine and spirits purveyor Brown-Forman Corp. to prison-builder Corrections Corp. of America have been invoking the "u" word with alarming regularity in earnings calls. There are few signs that that will change any time soon, even as the recession passes the 18-month mark.
Forecasting, never an activity companies felt particularly confident about, has now become nearly impossible. Processes that once resulted in mildly imperfect visions of the future now produce wildly imperfect ones. "The last 8 to 12 months have created a strong realization among many corporate leaders that whatever planning they may have been doing, they didn't factor in the possibility of the future being dramatically different from the past," says Andrew Blau, co-president of strategy consultancy Global Business Network.
Mark Gottfredson, global head of Bain & Co.'s performance-improvement practice, notes that, "in growth mode, executives can be very focused on their company and their industry. Even if they largely ignore GDP growth or what the government is doing, their forecasts will still be OK." With many once-stable macroeconomic factors now in flux, though, "companies need to look at many more variables," he says, including access to capital, country-specific risks, and structural changes within industries arising from the recession.
To cope, many companies are running the numbers more frequently, with an eye toward capturing different versions of the future. "Customers were doing reforecasts quarterly. Now they're doing them monthly, and augmenting them with a lot of 'what-if' analyses," says Ric Ratkowski, vice president of product marketing for Host Analytics, a budgeting-and-planning (B&P) software provider. A survey by CFO Research Services backs that up: about 80% of finance executives say their departments are spending more time on forecasting revenues and other financial metrics in response to the economic uncertainty, with an equivalent number amping up scenario planning in an effort to gauge the impact of alternate realities.
Host Analytics doubled its business in the past year, says Ratkowski; so has competitor Adaptive Planning, as finance departments automate B&P processes as one step toward creating better forecasts. But as the executives profiled below will tell you, there is no silver-bullet solution. CFOs who hope to emerge from the recession stronger can help their cause by driving improvements in corporate forecasting. To do that, they will need to gather relevant intelligence from far more sources, use it to project a range of possible outcomes, and then create detailed contingency plans for each. It's hard work, but Gottfredson says the potential rewards are substantial. "This is a great time for CFOs — major downturns are when industry decks really get reshuffled."
In Sickness and in Health
You might think a CFO in the health-care field could count on a fairly steady business, with illness being immune to economic cycles. But Tenet Healthcare CFO Biggs Porter has long had to deal with uncertainty, because even in the best of times he faces a paucity of information on potential patient admission levels and the profit they might yield. Tenet's revenues hinge on how many patients choose its hospitals and the types of insurance (if any) those patients carry. Yet statistics on market share for hospital services, the percentage of a population covered by commercial insurance, and the number of patients covered by COBRA (which might indicate an impending loss of insurance) are unavailable or woefully out of date.
On top of all that, current economic conditions mean that "the range of possible outcomes is significantly wider," says Porter, in that people's losing (or fearing they will lose) their insurance can alter their behavior in very different ways. Some accelerate elective surgery before their insurance disappears, for example, while others with high deductibles defer health services to conserve cash. Plus, there are few leading indicators of patients' inability to pay, and thus how much Tenet should reserve for bad debt. There is little correlation, for example, between local unemployment levels and the volume of uninsured patients. Last quarter, both the number of uninsured patients and bad debt accruals declined for Tenet, even as unemployment increased.
To overcome the vast number of unknowns, Porter starts with as much anecdotal evidence as he can glean about patient sentiment from physicians and other hospital staff. He then combines different forecasting methods, including a five-year "top-down" business plan based on broad assumptions and a two-year "bottom-up" plan that pulls together hospital-level projections. Next, he reconciles the two, the idea being that "either one could have bias or inaccuracies and by doing it both ways you can make adjustments to either model."
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