Wednesday, June 8, 2011

Managing Business Variation

It could be said  that it is not missed goals that kill a business, but rather the inability to anticipate and manage through business variation.  When businesses plan for the future, they often do it based on goals that are either arbitrary, or derived from the "averages" of historical experience.  While historical averages may provide decent directional guidance when it comes to setting business goals, they only tell part of the business cylce story.  Aside from the seasonal trends that a business may consider, a large degree of variation exists throughout the business cycle, due to forces beyond, or directly because of, management control.  Without an understanding of both the magnitude and drivers of business variation, managing business growth and sustainability can be a frustrating endeavor.

The key to understanding the magnitude of business variation is to understand how a business metric of interest, say revenue, varies over discrete time periods.  These periods could be days, weeks, months, quarters or years.  The period size depends upon the size of the business cycle being managed.  For example, if there is a need to manage a revenue goal for the next quarter, understanding the variability of past weekly or monthly revenue will help determine possible revenue ranges for the coming quarter.  As these ranges are derived from statistical distributions (like the bell shape curve), they will inform the likelihood that a goal may be met, or not.  If the revenue goal for the quarter $5M, and the statistical distributions indicate this only happens 5% of the time, there is a good chance that this goal will not be met.

Of course, nothing in business is static, so relying on pure statistical distribution of past results will not consider business or economic changes that may have caused shifts in business outcomes.  As such, it is important to study and identify the drivers that explain business variation.  The most basic and commonly understood driver of business variation is the seasonal effect that comes with most business cycles.  Other drivers may include factors that are within or out of the management's control.  These may include the strength of the market economy, resource investments, business model changes, supply chain prices, etc.  As these drivers begin to explain business variation, the ability to predict business outcomes for a particular situation becomes more precise.  It will become clear, after considering drivers of past performance, what  the range of expected outcomes is for the current environment.  From this, business goals may be set accordingly.

While point estimates and single value goals are simple and easy to understand, they do not communicate business risk that may jeopardize their realization.  By considering business variability and its inherent drivers, business goals may be set in a way that not only considers what is capable in a current environment, but also evaluates the risk that various targets will not be met.  It is by planning for this variation that risks can be mitigated, and surprises can be managed.

No comments:

Post a Comment