The [alleged] futility of forecasts

The whole of my professional raison d'être is to help decision makers—owners, managers, founders—look into the future.  Maximize profit, minimize risk, avoid unrecoverable mistakes, chose between or coordinate actions competing for scarce capital—the usual.

Experts of all kinds tout the need for formal planning. “Fail to plan = plan to fail” and so many grating cliches are trotted out to motivate us recalcitrant plebes.

Yet my long experience, corroborated by many colleagues--loan officers and credit analysts among them--testifies that businesses with true plans are in the extreme minority, at least in the small business subset.

I don’t want to go down an epistemological rabbit hole and would be rather bad at it anyway, so I affirm that planning broadly defined—taking actions with an intended effect in the future—is a constant in human action.  Whether it’s future assumptions embedded in a capital spend (“This machine will pay for itself in a year.”), ad hoc back-of the-napkins exercises, your well-oiled ERP system, the not unreasonable assumption that tomorrow looks like today 95 times of a hundred (until it doesn’t), or faith in the Lindy effect, everyone plans.

Profit, risk, mutually exclusive or competing uses of capital, and uncertainty are prone to incredible complexity.  Businesses, particularly capital-intensive (manufacturers and especially agriculture) quickly grow larger than any one mind can hold let alone communicate. The need for documentation in text, dollars, and other metrics, testable and susceptible to comparisons with actual results, grows with it.  Here’s my graphic, certainly not complete, but indicative of the process and the documentation.

 Here's George Box again, though:

“All models are wrong, some are useful.”

And with a slight modification to fit our topic, Nassim Taleb:

"All models are wrong, many are useful, some are deadly."

So then: what are good reasons for avoiding a documented, testable routine for planning?

Planning sounds anodyne.  It also sounds a bit totalitarian, command-and-control (Our New Five-Year Plan).   Business owners are subjected to a pretty continuous harangue about their failure to plan, the importance of it, the risks of not doing it, with all the attendant cliches (fail to plan, plan to fail, no goals = you’ll get there [nowhere], etc.).  It gets tiresome.  Looking at the bureaucratic snafus that are supposed to pose as foresight in large organizations doesn’t help the case.  One’s business is no one else’s to command and is not susceptible to the control of outsiders.  Planning can’t be done and it might even be wrong to try.

Planning also has the whiff of some professional class denizens muscling in on the owner’s sphere of responsibility, frankly a usurpation of authority.  Moral question aside, it can’t work.  Financial/economic literacy, or more often (and less usefully), professional certifications plus spreadsheets, are not operational competencies.  In presuming to be, they risk getting in the way of things that actually WORK.

In some industries no cash flow projection = no loan.  In others, apparently statistical credit metrics are regarded as more predictive than generated cash flows/plans/forecasts. 

In farming, operating loans are easily 70% of revenues and drawn up and down on an 18-month cycle.  Forecasts are required.  Sometimes the loan officer prepares them.  And yet: the measured profitability of the industry is barely breakeven, and in fact what floats many of them is the lender’s coverage via appreciating real estate.

Sidebar: I’m not commenting on the advisability for or against lender engagement at this level.  That’s definitely a topic worthy of another post.  At least unofficially, my sense is that in many cases if the lender didn’t prepare the cash flow forecasts they wouldn’t get done at all. 

Why plan if given time, virtue wins?  Keep your promises, respect your customers and employees, spend less than you earn, do good work.  No planning can fix the deficiencies in these areas, and instead, is too often enough turned into a means of “proving” that earnings would improve if we cheaped materials or labor because spreadsheets > reality (What did I just say about respect and promises?).

To encapsulate the case against planning:

1)      Invasion of the pencilnecks

2)      Known history > speculative future

3)      Principle >calculation

4)      It’s wishful thinking cosplaying as provable expectation because spreadsheets

5)      It can’t be done.

A summary of counterpoint

“Government, even in its best state, is but a necessary evil; in its worst state, an intolerable one.”  – Thomas Paine

People who do what I do easily forget our place: servant not authority.  There is no easy remedy for #1 above other than insisting that number crunchers are there to keep score, including prospective potential scores, not to play in the game.

In agreement with Mr. Paine, we are necessary and need to avoid becoming intolerable.

As to the second, history is speculative too.   We select our data and interpret it.  Both are subject to our biases both examined and tacit, reasonable and unreasonable.  As a practical matter, at least in running a firm, history is often best understood in light of what happens next.  Planning/forecasting actually shines a light backward as well as forward. 

“Markets can remain irrational longer than you can remain solvent”. – J.M. Keynes

Principle is indeed superior to calculation and the latter flows from principle whether you recognize those principles or not.  Right principle does win in the long run but if short run volatility upsets us, there is no long run.  Disaster is temporary, and principle will win out, but not for anyone knocked out of the game.  “Never cross a river that’s 6” deep on average.”  The average is very meaningful, yes; but so is the one day a year it becomes, without notice, a deadly torrent.

In short, we plan *because* we expect the unexpected, the Black Swan event (certainly an overused trope but apropos enough here).  Contra Keynes (who has much to be contra about), one can outlast an irrational market contingent on preparation—planning, if you will.

There’s no denying that wishful thinking can and does drive forecasts.  That’s not strictly planning, it is a performance to secure funding or meet some bureaucratic need for documentation.  Real planning is testing.  It’s iterative and refined by comparisons to actual.  It is not just aspirational, it allows for the extent to which we were able/willing to follow plans in the past.  If one has a good and long track record there, all manner of financiers will see it too and seek an audience with you. 

“If a thing is worth doing, it is worth doing badly.” – G.K. Chesterton

Planning can be done, although the fact that I’m marveling at its rarity suggest it’s neither easy nor fun.  That it’s so rarely attempted creates a low bar for the competitive advantage available.  Where few people sit down to plot the coming 24 months, the person who tries has a leg up just for trying.