THE BIG PICTURE – THE ECONOMY 165
The big picture – the economy
With regard to the big picture, you want to know two things. Where is the econ omy going
and how will it affect you? Generally, a greater level of economic activity boosts sales. A
downturn in the economy usually damages sales. You might have recession-proof prod-
ucts. If not, perhaps you should try to add some. When times are hard, people switch to
cheaper, basic goods and defer capital spending (focusing instead on maintaining what
they already own).
Forecasting with a ruler
If you have a long run of historical sales data you can break it down into a long-
term trend, a cyclical component and a seasonal pattern. The time series at the top
of Figure 8.1 – which might be sales of your product – is selected deliberately so
that you can see the constituent trends in the raw data. Normally, they are not so
obvious until you have analysed them.
1 Work with volume (quantities) – the top series in Figure 8.1.
2 Use regression analysis, a moving average or even a ruler to draw a line of
best fit. This is the long-term trend – the second series in Figure 8.1.
3 Divide each value in the original series by the corresponding value read from
the trend line. This gives you an indication of the cyclical component – the
third series in Figure 8.1.
4 Identify the seasonal component (simplistically, take the average of all the
January figures, all the February figures and so on) – the final series in Figure 8.1.
There will also almost certainly be some unexplained spurious noise that does not
fit into any one of these categories. If it is very large, this technique will not work
well for the data that you are examining.
From the three components shown, you could produce a reasonable forecast by
extrapolation. You might extend the trend with a ruler, continue the cyclical wave
freehand, calculate the seasonal variation and then multiply them all back together.
Such forecasting is sometimes adequate, especially if time and money are in
short supply. However, a much better approach is to look for intimate relationships
between the series and some leading indicators – see page 167.
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166 CHAPTER 8 GETTING TO GROSS PROFIT
Value or volume
Observed, raw data
Value or volume
Trend
Value or volume
Cycle
Value or volume
Seasonal
Time
Figure 8.1 All this from one set of figures
THE BIG PICTURE – THE ECONOMY 167
Start by examining your track record if you can. If you do not have a history that you can
use to identify the relationships described below, you should be able to develop a rea-
sonable understanding of the forces that will affect sales once you have launched a new
product. You can use this to help project sales. Doing so and documenting it carefully will
add credibility to your business plan.
INTIMATE RELATIONSHIPS/LEADING INDICATORS
Take another look at your review of the world (Chapter 5). With any luck you will quickly
spot several important factors that affect your sales. In particular, you might know about
intimate relationships that help you predict the way that demand varies for a particular
product or product category.
For example, sales of concrete and carpets are influenced by the level of house-build-
ing activity. The time lags are different. Concrete is poured when foundations are started.
Carpets are laid several months later. This is a simplistic example, in which house-building
activity is used as a leading indicator of demand for concrete or carpets.
The relationship is illustrated in Figure 8.2. Carpet sales are shown in the top chart. The
lower picture shows housing starts moved forward by a year. Note how the two series
move broadly in tandem. You might use the lower chart to predict future sales. It suggests
that they are about to rise.
Ignoring the thorny issue of cause and effect, an increase in consumer
demand is linked to greater industrial activity overall. Even if your
customers are industrial and commercial buyers you will still be affected by
demand at the consumer level. For example:
consumers buy more washing machines, so
home-appliance manufacturers buy more steel products from your
customers, and
your customers buy more steel from you.
These are examples of companies undertaking successful marketing activities
directed at stimulating buying by their customers’ customers.
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168 CHAPTER 8 GETTING TO GROSS PROFIT
In fact, you usually need to use several leading indicators. For example, demand for car-
pets will depend on new house sales, office completions, turnover of existing properties,
companies’ financial surpluses, household disposable income and so on. Each of these
indicators will have some influence on demand for carpets, each with a different time lag.
Do not forget that the relationships can be turned upside down (for example, if interest
rates go up, carpet sales go down).
Governments and some private associations publish enormous amounts of useful eco-
nomic data for you to explore. Always look for underlying influences – house-building in
the example shown here. You might get away with making mistakes such as using sales of
concrete to estimate demand for carpets but I am sure that you can see the dangers.
Where you can justify intellectually that relationships might exist, draw graphs to see
if they do and how tightly the series are correlated. Use your results for the past few years
plotted monthly or quarterly. Sometimes, percentage changes over 12 months (or 4 quar-
ters) magnify trends, making them easier to spot. There are statistical techniques that add
rigour to the analysis, such as correlation and regression analysis. If you know about this,
use it. Computer software, including simple spreadsheets, makes it very easy.
Quantity
Carpet sales
Time Today
Quantity
Housing starts
Time Today
Figure 8.2 Intimate relationships illustrated
THE BIG PICTURE – THE ECONOMY 169
Once you have established a relationship between some external force and your sales,
you can use it to predict the future. Leading indicators do not usually show you enough
of the future. However, you can follow the linkages all the way to the top. An overall eco-
nomic forecast will allow you to forecast your key leading indicators which in turn will
permit you to forecast your sales.
ECONOMIC FORECASTS
You could produce economic forecasts yourself. However, governments, universities, eco-
nomic institutes, bankers and consulting houses throw enormous resources into building
economic models and forecasts. The results are published, often in great detail and often
for free. Why not use them? Beware, though, the only thing that you know with cer-
tainty is that the forecasts will be wrong (and I speak as an ex-economist). Examine track
records, review the forecasts with healthy scepticism and be prepared to modify them in
the light of experience and new information.
You can usually find leading indicators that help with your forecasting. You
might also be able to use them as active management tools. For example,
suppose your sales always turn down 18 months after the point at which
interest rates reach their trough and start rising again. This makes it fairly easy for
you to schedule purchasing, inventory, capacity use and so on.
But watch carefully. Relationships can change. It pays to identify several
indicators with different leads and lags – so that you can confirm the signals
transmitted by each one. You can track the indicators in a quality newspaper
such as the Financial Times. If you are really keen, go to the source: check out the
websites of your government statistical offices, departments of trade, industry,
etc., and the central bank, as well as research bodies and trade associations which
produce surveys and figures. International organisations such as the OECD and
the World Bank publish very useful data and commentary, especially if you are
operating internationally or just want to keep abreast of global developments.
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Watch for surveys of business confidence. Directors and managers just like you
are asked leading questions about their current experiences and expectations.
The results are summarised and published (I should definitely mention the
Financial Times again here). Look for indicators such as purchasing plans, investment
intentions, distribution activity and so on from bodies such as the Institute of Directors
in Britain, confederations of industry in Australia and the UK, the IFO in Germany,
government statisticians in the US and Japan, and many other sources.
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