CASE 12-2 PRECISION TOOLS, INC. Revision of Sales Forecasting Model t seems to me that our...

  

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CASE 12-2 PRECISION TOOLS, INC. Revision of Sales Forecasting Model t seems to me that our forecasting system, which we have been so proud of for so many years, has sprung a leak. Our forecasts used to be on the money. Now suddenly we missed by 18 percent two years ago and 22 percent last year. Business was bet- ter than we thought it would be, so we missed a lot of sales by underplanning production. Something seems to be wrong and it's causing us to lose mar- ket share because we don't have enough inventory to supply the demand. What are we doing about it, Pat? David Haeppner, president of Precision Tools, Inc., of Salt Lake City, Utah, was talking to Pat Michaels, the company's vice president of sales operations. Precision Tools, Inc. designed, made, and dis- tributed a wide line of specialized machine tools used in light manufacturing operations. Most of the firm's products were computer driven; thus, the firm also was involved in developing the soft- ware needed for operating the machines. Ten years ago, the firm's market analyst had developed a relatively simple model for forecast- ing the demand for the firm's products based on the payroll and employment statistics of the firms included in the SIC categories of the company's target markets. Management became increasingly comfortable with its forecasting model, which provided excellent forecasts for a while. However, the model underestimated sales by 22 percent last year. It was not known how much more the com- pany could have sold had it been prepared for the unexpected demand. One sales rep was heard to say, "If this is a recession, let's have more of it." While the firm's customers had reduced their payrolls and employ- ment, their manufacturing activities were increas ing. Their increased profits were encouraging their purchase of machine tools. Thus, business was good for Precision Tools, contrary to what its forecasting model had predicted. In response to the president's question, Pat Michaels replied, "I have asked Cori Newman to develop a new forecasting system for us since it has become obvious that the previous relationship between employment and our sales has changed." "Call her in! I want to know where we now are and where she is in her thinking." David Haeppner handed the phone to Pat Michaels as he dialed the extension. Cori Newman had joined the company as market analyst after working for Microsoft, a soft- ware developer in Orem, Utah, for four years in its marketing research group. She was a graduate from Brigham Young University's MBA program. She quickly responded to the request for her pres ence in the executive conference room and took with her the portfolio of work she had already done on the forecasting problem. After observing the usual courtesies, Newman began. "As we have suspected, the relationship between employment and machine tool demand has changed. This is a common problem encoun- tered in all forecasting models based on an analysis of historical relationships. Relationships change! We can easily reformulate our existing forecasting equation to determine whatever new relationship evolves between employment and machine tool demand, but probably that new equation would have to be repeatedly revised. "I also would like to point out that sales fore- casts tend to become self-fulfilling prophecies. If the forecast is low, that is what the company will likely sell. A high forecast likely increases sales through the combined forces of more inven- tory and more marketing pressure." Newman noted that her audience was receptive so far to her thoughts. She continued, "We have some alternatives. We could ask our customers about their plans for buying our tools the coming year. Academics call it surveying buyers' intentions. We 368 Chapter 12 Forecasting and Budgets could do it since our total number of customers is not large. The salespeople would contact all of their accounts to find out what they plan to buy for the next budget. Then the salespeople sum- marize what they discovered and make a forecast of their sales. We then summarize all of the sales- people's forecasts to come up with our own. One advantage of this procedure is that we can develop forecasts in more detail, by product lines." Then you're recommending that we abandon our mathematical approach to forecasting and go to a survey method. Is that right?" the president asked. "Not necessarily. I am trying to give you an idea of the different approaches we can use and let you make the decision," Newman replied. "Whoa! I have trouble with that. You're sup- posed to be the expert in market analysis, not us. We hired you to tell us what you think we should do. I want a recommendation from you without any equivocation." Pat Michaels firmly told Cori Newman what was expected of her. Newman was inwardly shaken by Michaels' aggressive position but tried to maintain her composure. She replied, "Very well, you'll have my recommendation in writing Monday moming." After exchanging the usual parting words, she returned to her office to begin what would be a hectic weekend. She mulled over the other forecasting alterna- tive that she had not been allowed to present at the meeting. She had been about to tell her bosses that she could develop another mathematical model based on data other than employment. She would have to do a lot of statistical work to locate and validate such a series of information, but, after all, that was her job. Cori Newman wondered if she should recom- mend continued use of a forecasting method with which management was familiar or if she should recommend switching to the survey of customers' buying intentions system. Question: 1. What forecasting method should Cori Newman recommend that Precision Tools adopt? CASE 12-2 PRECISION TOOLS, INC. Revision of Sales Forecasting Model t seems to me that our forecasting system, which we have been so proud of for so many years, has sprung a leak. Our forecasts used to be on the money. Now suddenly we missed by 18 percent two years ago and 22 percent last year. Business was bet- ter than we thought it would be, so we missed a lot of sales by underplanning production. Something seems to be wrong and it's causing us to lose mar- ket share because we don't have enough inventory to supply the demand. What are we doing about it, Pat? David Haeppner, president of Precision Tools, Inc., of Salt Lake City, Utah, was talking to Pat Michaels, the company's vice president of sales operations. Precision Tools, Inc. designed, made, and dis- tributed a wide line of specialized machine tools used in light manufacturing operations. Most of the firm's products were computer driven; thus, the firm also was involved in developing the soft- ware needed for operating the machines. Ten years ago, the firm's market analyst had developed a relatively simple model for forecast- ing the demand for the firm's products based on the payroll and employment statistics of the firms included in the SIC categories of the company's target markets. Management became increasingly comfortable with its forecasting model, which provided excellent forecasts for a while. However, the model underestimated sales by 22 percent last year. It was not known how much more the com- pany could have sold had it been prepared for the unexpected demand. One sales rep was heard to say, "If this is a recession, let's have more of it." While the firm's customers had reduced their payrolls and employ- ment, their manufacturing activities were increas ing. Their increased profits were encouraging their purchase of machine tools. Thus, business was good for Precision Tools, contrary to what its forecasting model had predicted. In response to the president's question, Pat Michaels replied, "I have asked Cori Newman to develop a new forecasting system for us since it has become obvious that the previous relationship between employment and our sales has changed." "Call her in! I want to know where we now are and where she is in her thinking." David Haeppner handed the phone to Pat Michaels as he dialed the extension. Cori Newman had joined the company as market analyst after working for Microsoft, a soft- ware developer in Orem, Utah, for four years in its marketing research group. She was a graduate from Brigham Young University's MBA program. She quickly responded to the request for her pres ence in the executive conference room and took with her the portfolio of work she had already done on the forecasting problem. After observing the usual courtesies, Newman began. "As we have suspected, the relationship between employment and machine tool demand has changed. This is a common problem encoun- tered in all forecasting models based on an analysis of historical relationships. Relationships change! We can easily reformulate our existing forecasting equation to determine whatever new relationship evolves between employment and machine tool demand, but probably that new equation would have to be repeatedly revised. "I also would like to point out that sales fore- casts tend to become self-fulfilling prophecies. If the forecast is low, that is what the company will likely sell. A high forecast likely increases sales through the combined forces of more inven- tory and more marketing pressure." Newman noted that her audience was receptive so far to her thoughts. She continued, "We have some alternatives. We could ask our customers about their plans for buying our tools the coming year. Academics call it surveying buyers' intentions. We 368 Chapter 12 Forecasting and Budgets could do it since our total number of customers is not large. The salespeople would contact all of their accounts to find out what they plan to buy for the next budget. Then the salespeople sum- marize what they discovered and make a forecast of their sales. We then summarize all of the sales- people's forecasts to come up with our own. One advantage of this procedure is that we can develop forecasts in more detail, by product lines." Then you're recommending that we abandon our mathematical approach to forecasting and go to a survey method. Is that right?" the president asked. "Not necessarily. I am trying to give you an idea of the different approaches we can use and let you make the decision," Newman replied. "Whoa! I have trouble with that. You're sup- posed to be the expert in market analysis, not us. We hired you to tell us what you think we should do. I want a recommendation from you without any equivocation." Pat Michaels firmly told Cori Newman what was expected of her. Newman was inwardly shaken by Michaels' aggressive position but tried to maintain her composure. She replied, "Very well, you'll have my recommendation in writing Monday moming." After exchanging the usual parting words, she returned to her office to begin what would be a hectic weekend. She mulled over the other forecasting alterna- tive that she had not been allowed to present at the meeting. She had been about to tell her bosses that she could develop another mathematical model based on data other than employment. She would have to do a lot of statistical work to locate and validate such a series of information, but, after all, that was her job. Cori Newman wondered if she should recom- mend continued use of a forecasting method with which management was familiar or if she should recommend switching to the survey of customers' buying intentions system. Question: 1. What forecasting method should Cori Newman recommend that Precision Tools adopt?