“A goal without a plan is just a wish.”
― Antoine de Saint-Exupéry
“You can always change your plan, but only if you have one.”
― Randy Pausch, The Last Lecture
Operational planning differs from strategic planning. Strategic planning is the process that defines the business’s direction, overarching goals and competitive advantage. An effective strategic plan is the foundation executives use to make decisions allocating resources and choosing between alternatives. Operational plans on the other hand focus on specific outcomes and the initiatives necessary to advance the business’s goals and objectives (typically confined to a period of one year). The operating plan expresses accomplishments, action items, initiatives, budgets, scheduled milestones, and assignment of responsibilities expected over the coming year. Operational planning and the operating plan produced are most effective when delegated to individual revenue and cost centers. Plans prepared by individual operating units can be consolidated into a company-wide plan. Doing so provides executives the information needed to ensure the business as a whole can achieve its strategic goals. To be effective, operating plans need to be clear, actionable, temporal, assignable and measurable.
COPING WITH CHANGE, REDUCING UNCERTAINTY & MANAGING RISK
“Risk comes from not knowing what you’re doing”
― Warren Buffett
Planning is about confronting and managing uncertainty. Operational planning is not a speculative folly trying to predict the future. Thinking so exemplifies a common misconception of planning’s purpose and value. Meaningful operational planning is the tool required to mitigate the consequences of uncertain. Mature and successful businesses can be distinguished by the presence of planning competencies.
The primary purpose of operational planning is to expose, understand and remedy uncertainty. Thinking about planning in this regard requires developing the ability to distinguish between significant and insignificant uncertainty. To make this distinction it is useful to dissect uncertainty into two different components: likelihood and consequence. Taken together, likelihood and consequence, allows the planner to allocate precious time to resolving what is important and dismissing (or deferring) what is not. Additionally, the discipline of operational planning, when performed effectively, provides a systematic framework to convert uncertainty into knowledge.
Let me illustrate with a look at revenues. One of the common topics of operational planning is the development of a forward looking estimate of revenues. It would be easy enough to project future revenues by multiplying last year’s revenues by the desired growth rate. A method commonly used. Projecting future revenues by simply escalating historical revenues may produce an attractive spreadsheet but it will yield limited useful knowledge. Resorting to this simplified method often hides useful insights. Alternatively, parsing future sales into what is known and what is not known reveals information that can be applied to allocating resources and time.
A recent engagement required determining the adequacy of a client’s deployable capital as well as an appropriate capital structure. Quickly, it was determined that the company had inadequate access to deployable capital necessary to satisfy its demand for working capital. Moreover, the existing capital structure was overly burdened with debt. This led to the conclusion that approximately $5 million in fresh equity was need (in addition to a restructuring of the existing debt capital).
In order to successfully re-capitalize a comprehensive business plan was required that included expressing the Company’s expectations for future revenues. The conventional approach to forecasting future revenues uses historical sales escalated with an assumed growth rate. The senior executives of our client expressed their belief that a 15% increase in revenues was a reasonable escalator. Using this escalation factor, together with other assumptions provided by the company’s executives, an estimate of capital requirements was derived. These assumptions also indicated that cash flow and earnings would be adequate to provide an appropriate return to both debt providers and equity investors. However, when the senior executives reviewed the sales forecasts they reacted with disbelief. These executives could not imagine how they could produce the sales forecasted.
The executives reacted by dismissing planning as meaningless. This initial reaction however missed the point. These executives were focused on a single number – projected sales. Rather than reacting with skepticism the executives would be (and eventually were) better served by asking where those future revenues might come from. That question focuses on understanding uncertainty, rather than just impulsively dismissing the plan which is nothing more than just surrendering to ignorance. Focusing on the source of projected sales led to thinking about future revenues as composed of three different categories; Confirmed, Anticipated and Gap.
Certain future sales can be anticipated with a high degree of confidence. These future sales may currently exist as contracts or purchase orders for future deliveries. These Confirmed sales can be identified as a line item labeled Confirmed. Other sales may not yet be contractually confirmed but the company may know from history that a certain customer buys a certain number of units. These future sales cannot yet be treated with the certainty of a Confirmed order but the volume and customer can be reasonably anticipated. These are entered on a second line labeled Anticipated. The third line “Gap” represents the sales whose origins are not yet known but required to satisfy the company’s revenue growth expectations. It is the uncertainty of the Gap revenues that is significant. Parsing out Gap revenues in this way, expressed both quantitatively and in context, was what the executives needed to believe their own growth assumptions and more importantly to devise an action plan to achieve those expectations. Revealing the scale of gap sales led executives to focus on how to acquire new customers or new sales to existing customers.
Presenting sales as Confirmed, Anticipated and Gap changes the nature of the revenue uncertainty. The uncertainty is no longer how we generate total sales but rather how to ensure anticipated sales occur and where to find Gap sales. By narrowing scope of uncertainty from all sales to anticipated and gap sales executives can focus their attention and energy towards the real issue.
The essence of this approach is to divide the problem into two pieces: what’s known and what’s not. Continuing to break down uncertain into known and unknown eventually leads to an uncertainty that is manageable. Referring back to the previous example, where will the Gap sales come from.
The work we do for clients commonly includes preparing or clarifying business plans and financial forecasts. Contrary to popular belief we don’t make up these numbers; we translate what our clients tell us about their business and their plans for the business into a concise narrative and a quantitative financial expression. I cannot begin to guess how many times I have heard clients tell me, after reviewing these forecasts “I don’t believe these numbers. We can’t predict what will happen in the future.” In one sense these comments are absolutely true – none of us can predict the future. This comment however exposes a dangerous naïveté – dismissing the importance of managing uncertainty and change. I cannot predict the future, I am however confident that the future will be different than the present. That simple sentence expresses two essential realities businesses confront; change and uncertainty.
Mature companies respect the importance of uncertainty and develop the ability to manage it; sometimes giving them powerful competitive advantages. Managing uncertainty and change is essence of operational planning.
THE MECHANICS OF OPERATIONAL PLANNING
“If you don’t know where you are going, you’ll end up someplace else.”
― Yogi Berra
Mountains of books have been published offering guidance on the appropriate techniques for constructing an operational plan. I have no intention of prescribing any particular planning methodology, rather to emphasize its critical importance and offer a few words of guidance. Most importantly, is to adopt a corporate culture that explicitly acknowledges and confronts change and uncertainty. Senior executives of mature and successful businesses embrace the idea that change and uncertainty is their primary responsibility. The sophisticated executives use change and uncertainty as a source of competitive advantage devising the business infrastructure required to effectively and rapidly reveal change as well as to respond to uncertainty.
The mechanics of Operational Planning is composed of four components: 1) expected outcome; 2) planning premise; 3) thoroughness; and 4) ownership. Planning is performed for the purpose of achieving an outcome. In some cases the outcome is predictable and stable while on other occasions the ultimate outcome may evolve as a result of rigorous planning. Understanding, at the onset, the nature of the outcome is critical. In some cases the outcome may be as simple as knowing the scale and origins of future sales. However, it is just as likely that a rigorous planning process may reveal that the real outcome should be confirming the specific satisfaction customers seek. I don’t suggest that one kind of outcome is any better than the other, only that the quality and achievability of the operating plans depends on how well the outcome is understood.
There is a necessary mindset that needs to be in place to ensure that operational planning serves its purpose – the planning premise. That premise is that the planning process can reveal and mitigate uncertainty only when the right questions are asked.
There is a need to be holistic when performing operational planning. When an operational plan is designed to ensure that the company’s strategic objectives are satisfied it requires considering every possible influence. Meaning it is not just top-line revenues but also includes considering cost structure, pricing, resources, people, competitors and outside business environment – thoroughness.
At the end-of-the-day achieving an expected outcome and producing superior performance is the result of effort applied by the individuals responsible for business execution. The command and control approach, delegating goals and prescribing approaches, fails. Harnessing the energy and imagination of the individuals that make-up an organization requires ownership. A robust operational planning approach specifies the organizational goals and objectives then seeks individuals to “sign-up” (assume responsibility) for the specific goals that they are qualified and motivated to achieve. This requires delegating the specifics of the operational plan to the individuals who will ultimately have responsibility for execution. The responsibility of executive management is to ensure that the consolidation of business unit goals and initiatives satisfy the businesses overall objectives. This oftentimes means pushing business unit leaders and other individuals to be aggressive and imaginative. But this push is not prescriptive or threatening rather it is a challenge to individuals to push boundaries and discover new levels of achievement. It is creating a culture and a working environment that encourages individuals to trade the comfort of routine for the rewards of accomplishment. A noble goal and the secret to superior performance.