January 19, 2010

Planning: Tops-Down and Bottoms-Up Approaches

There are two steps that happen in typical Sales Planning strategies.
  1. Tops-Down Sales Estimates.
  2. Bottoms-Up Sales Estimates.

The typical "Tops-Down" Sales Estimate is generated by a business leader. This person estimates what is likely to happen as strategies change.

The typical "Bottoms-Up" Sales Estimate is generated by a business analyst. This person is "in the trenches", generating a forecast from segment-level data, marketing campaign performance, key performance indicators, or customer projections.

The "Tops-Down" forecast and the "Bottoms-Up" forecast should be directionally similar. If they aren't, somebody must reconcile why the numbers are not directionally similar.

I tend to spend all of my time in the "Tops-Down" realm. My job is to create forecasts that are reasonable. So when a CEO wants to increase the marketing budget by 20%, I need to generate a reasonable sales increase to pair with the marketing increase.

When I don't have good data, I use a simple "square root" relationship to quantify my "Tops-Down" forecast. Let's say that we can attribute $20,000,000 to marketing efforts, and Management wants to increase marketing spend by 20% next year.

  • Tops-Down Forecast = $20,000,000 * (1.20 ^ 0.5) = $21,909,000.

I use the "square root" approximation because I want to discount the benefit of additional marketing spend. We seldom see cases where an incremental $1 investment in marketing yields an incremental $1 of sales. The "square root" approximation does a reasonable job of generating a "Tops-Down" forecast.

When the marketing analyst generates a sales forecast at a "Bottoms-Up" level, it should be directionally similar to the $21,909,000 estimate I generated. If I see $21,600,000, or $22,300,000, I feel confident that the analyst did a good job. If I see $24,000,000, I know that the analyst did something wrong --- there must be proof offered to demonstrate that a 20% increase in advertising will yield a forecasted 20% increase in demand.

These are the ways that "Tops-Down" and "Bottoms-Up" approaches reconcile to yield accurate sales forecasts. Ok, your turn. What methods do you use to reconcile sales forecasts?

2 comments:

  1. Hi Kevin,

    As you know, I recently wrote about the benefits of using Monte Carlo simulations in forecasts to focus decisions on the probabilities of various potential outcomes. (http://www.retailshakennotstirred.com/retail-shaken-not-stirred/2010/01/why-most-sales-forecasts-suck-and-how-monte-carlo-simulations-can-make-them-better.html)What are your thoughts about implementing such a methodology in this type of situation? It seems to me it's important to understand the variability possible in uncertain situation like this type of forecast.

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  2. Sure, Monte Carlo simulations will work just fine. Just need to make the culture of a company comfortable with the methodology, something that is always harder than implementing the methodology itself.

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