Forecasting is a collection of mostly statistical and/or judgmental procedures which aim at predicting the future based on the available information and/or data (These processes may include activities such as data collection, data pre-processing and preliminary data analysis, forecasting method selection, which also involves model selection, model fitting, and diagnostic checking, and control in a forecasting system in use). In such processes, forecasting has lots of potentials for strategic level managers including revealing system dynamics, problem determination, predicting, monitoring, and control.
Forecasting techniques are used by managers to plan future capacity to meet market demand and to procure the needed inputs to produce this demand at optimum costs. Forecasting models are used to predict future aspects of business operation. They include averages, moving averages, weighted moving averages, exponential smoothing, linear trend models, and simple and multiple regression models.
Forecasting as a Strategic Decision-Making Tool
Surviving in highly competitive markets and adapting to new states require both strategic thinking and utilizing all the available information about the future, as well as that about the present. Nevertheless, the information required about the future may not always be readily available. Even though it is possible to obtain a part of those data and/or information (e.g. inflation figures, growth forecasts, exchange rates) from external sources, firms mostly produce and obtain the required data (e.g. the amount of future stocks, cash flows, market shares) themselves within their own bodies. Moreover, firms, themselves, may also have to produce some of the external data needed (e.g. inflation rates and exchange rates) for themselves, which could normally be obtained from external providers otherwise.
Strategic management is applied in three different levels: Corporate, business, and functional levels. In fact, the functional level management is the main management unit where the strategies in a company are put into action. In strategy formation, the business and corporate level managers need and use the information being fed from the functional level. Forecasting activities can take place anywhere in these three levels based on the managerial needs and forecasting problems. However, as we get from top to bottom of managerial levels, the more intensive and more frequent forecasting function is utilized.
On the other hand, strategic decisions mainly focus on creating ‘competitive advantages’ and differ from other daily or operational decisions from several aspects. Some of the characteristics of strategic decisions are that (i) they are made less frequently than (e.g. daily) operational decisions; (ii) they are generally more costly (in terms of the decision-making process e.g. may require longer time and more money, and the alternative costs) to make compared to other type of decisions; (iii) the consequences may be too severe for the firm; (iv) it generally requires background work and longer time to make; (v) they may normally require more and detailed information (e.g. data and (full) analysis of the situations, which may not be a pre-condition for ordinary daily decisions). The decisions such as market segmentation, new product development, application of new manufacturing process, selection of a new distribution channel, and application of a new marketing mix, all can be considered as strategic decisions. Similarly, the major decisions directed at obtaining substantial cost reductions can significantly contribute to gaining competitive advantages and, that is why, can be considered as a strategic type. More specifically, forecasting of costs, market share, sales, inventory, cash flows, dividends, stock prices, and capacity requirements, which are only some of the internal utility areas, besides interest rates, inflation rates, and growth rates of economy, which are some of the external utility areas, all are closely related to strategic decision-making in one way or another.
The operation of the forecasting function, in this sense, is an inter-departmental activity and, therefore, the development of forecasts (e.g. sales or market potential) should be done by the inclusion of several parties (e.g. market research manager, sales manager, and production manager in a company). This is particularly important for especially if the forecasts are used for strategic (e.g. marketing) planning, integration, and realization of those strategic plans.
Integration of forecasting system to management activities is particularly important in utilizing the potential of forecasting, which has two main dimensions: (i) the production of the desired forecasts and (ii) putting them into use. As the first one is related to the forecasting function, the second one is related to the managerial decision processes. As with any other decision tools, a failure in utilizing it will make it difficult to achieve the desired objectives, especially if a particular decision is heavily based on the information from the forecasting system such as the decisions regarding manufacturing capacity planning based on sales forecasts).
According to Palot, the potential uses of forecasting in strategic decision processes can be stated as follows:
- Goal Setting: Strategic planning requires input and the forecasting system in a company provides the underlying input necessary for the underlying process. Strategic managers can base their plans on these inputs in determining more realistic and attainable goals. In other words, forecasts can be taken as benchmarks for determining what are (are not) possible and achievable goals in a managerial decision context.
- Firm Performance: The information produced by the forecasting system is ready-to-use material for measuring the firm performance and whether the predetermined strategic goals are achieved. Hence, forecasting can be used as a performance evaluation and a monitoring device in assessing the success of strategic plans. Assume that company X forecasted its market share to be 25% in a 3 years’ time and determined all its strategies to attain this market share. At the end of the 3 years period, strategic management could easily use market share forecast as a benchmark for evaluating to what extent it achieved its objectives or how well it performed during these last 3 years, so that it can refine its strategies.
- Strategy Formulation: Strategy formulation is one of the key processes in strategic management. Broad range of forecasting processes provides with company managers the relevant information from procedural and analytical designs so that the outcomes from various scenarios can be investigated and taken as a ground for such processes and activities. This would give managers the opportunity to make more realistic assumptions in their plans and projections and determine alternative strategies concerning different outcomes of forecast results for the scenarios being considered.
- Strategy Implementation: Strategy implementation is another key process in strategic management. The attainability and consistency of strategic objectives are particularly significant for strategic management levels. The strategic objectives expressed in clear and objective figures are the key elements in strategy implementation. Good communication between strategic managers at all levels is a prerequisite for achieving these objectives, which requires clear, concrete, and understandable messages. Forecasts produced, in this sense, are a major part of the messages in the communication between both different levels of strategic and operational managers, and among themselves, as well.
The same as in the strategy formulation, without the flow of information (and data) from the top level to the functional level, the opposite of above, the functional level managers would not know what strategic objectives are pre-determined; in turn, what the functional level objectives should accordingly be, what functional decisions to make, and what tools to use for monitoring and control purposes. In other words, without concrete strategic goals accompanied by figures, which are made more concrete and visible by forecasts, it would be too difficult to implement the strategies determined.
It was also suggested by Palot that forecasting can be used in two different ways for strategic purposes:
- For the realization of strategic decisions in functional and operational levels (e.g. short-term operational forecasts which should normally be the basic guide in running the business’ daily operations).
- For planning strategic decisions directly (e.g. medium term and long term capacity forecasts based on market potential).
Medium or longer term forecasts can directly be considered for strategic planning purposes mainly because they have to consider economic, political, social, demographic, and other relevant external (or internal) characteristics. Good sales forecasts start from forecasting of the general state of an economy, and goes to forecasting of the specific industry and then to the market potential and sales for a specific period of time. Within these processes, it is expected that various scenarios are considered and a different set of forecasts for each scenario is produced. Here, strategic thinking is an integral part of forecasting for different scenarios and the end product is a set of information obtained from such processes, made ready to be used for strategic purposes.
The forecasting function is related to the strategic management context as follows: Strategic decisions are long-term in nature. Long-term decisions are riskier than short-term decisions due to an increase in the uncertainty in the long-term. The higher the increase in uncertainty, the more the managers’ need for information for strategic decision-making. In principle the longer the time horizon is, the higher the planning requirements are (e.g. capacity planning) in companies. It is obvious that in such situations the information requirement by management increases dramatically, especially, if the intention is to make strategic decisions, which makes forecasting central to strategic decision-making. Cost considerations are another factor that forces strategic managers to consider forecasting. A forecasting activity with a high accuracy may be needed especially in major planning and investment decisions based on the forecasts of market potential or sales where high costs are incurred (e.g. plant expansion and new facilities construction). The size of the costs or financial resources to be invested may make firms utilize the forecasting function in making a ground for such decisions.
Reference: Polat, Cihat Forecasting as a Strategic Decision-Making Tool: A Review and Discussion with Emphasis on Marketing Management, European Journal of Scientific Research, 2008 Volume 20 Number 2, pp.419-442