Ramon Ecung's Personal Blog

Forecasting revenues is a tricky business. Two common errors (called Type 1 and Type 2 errors) made are forecasting too many sales and operating at a negative cash flow until your fume date, or underestimating sales and not having enough capacity to meet demand.

The best way to negate these errors is to come up with a best case, worst case, and “most-likely” case senario based on your experience, any similar products/services, and/or the experience of trusted advisors. You can plan for the most-likely case, but if things go wrong (or right!) you can be agile and quickly adjust to meet current demand.

In my past experience, I’ve worked with a company that didn’t formally forecast revenues. I suppose this could be called a Type 0 error. It would be verbally stated what orders are coming down the pike, and if more revenues needed to be generated to operate the business, all the team members would either jump into sales mode or focus on supporting the sales team. One reason I think formal revenue forecasting never happened was because it was so hard to forecast if people would need the services the company provided. That turned into having very informal processes.

It’s especially hard to forecast sales in high tech markets. Imagine if you were in charge of designing the iPhone, a product that essentially merges two commodity products into one. They weren’t the first to make a phone that play’s MP3’s, and they weren’t the first to have high capacity storage on phones (many phones can now use up to 16GB expandable storage cards). Apple probably developed a sales forecast for the phone if it got negative reviews (thus bad sales), moderate sales based on it’s $499-$599 price for the iPhone 2g, and great reviews/sales.

As it turned out, they got great reviews and sales, but they were constantly sold out for many months after the product was released. This shows that they didn’t go “all in” on their forecasting. They maxed their capacity and scrambled to make more units to keep up with demand. Had they planned for the best-case senario but the phone got bad reviews (they did have issues with stuck pixels on the initial units), they might have been stuck with phones that no one would buy for $500+ and had to either discount the units to sell at a loss or suffer with their cash tied up in slow moving merchandise.

Revenue forecasting is especially a problem for the enterprise when their intrapreneurial units develop a product. If upper management can’t correctly identify a potential market (like Xerox did for electronic copy machines) they may lose out on potential revenues (like Xerox did when they developed an electronic pointing device for the computer, also called a mouse).