America’s Future Management

Panic Ordering.DuPont–whose products are used in everything from medical equipment to clothing, carpeting, and paint – has been through countless economic swings. Managers there have learned to pay close attention to such macroeconomic factors as oil prices, currency fluctuations, inflation, and Federal Reserve policies. That’s how DuPont was able to figure out as far back as July, 2000, that business was deteriorating. DuPont cut back early, keeping layoffs and write-offs to a minimum. The main warning signals then: high energy prices, lackluster apparel sales, and government-reported declines in new factory orders.

Even for the most experienced hands, forecasting demand is an inexact science. At Massachusetts Institute of Technology’s Sloan School of Management, students and executives for years have played “the beer game”, where they take the roles of brewer, distributor, wholesaler, and retailer, and try to estimate demand across economic cycles. Nearly everybody gets it wrong – especially those who are farthest from the customer. The trick, says MIT Professor John D. Sterman, is to figure out how the ultimate customers are behaving and produce to suit them, not the manufacturers, distributors, or retailers in-between. So-called panic-ordering and other distortions only confuse everyone. Says Sterman: “If you are in the pasta business, you want to know how much pasta people are cooking and eating, not how much they are buying, and certainly not how much supermarkets and distributors are ordering from the factory.”

Gathering good information, of course, doesn’t guarantee acting wisely on it. Car makers, for instance, regularly get a better-than-average fix on overall demand as their in-house economists pour over such time-tested data as household formation rates and consumer confidence surveys. “The forecasting is pretty good,” says David J.Andrea of the nonprofit Center for Automotive Research. The problem, he says, is “industry behavior.”

Detroit still winds up during a slowdown with at least some excess inventory . Why? Each carmaker bets that its models will outsell the rest and produces accordingly. Later, too, the Big Three carmakers have sullied their profit margins and clouded forecasting by offering steep incentives to buyers. Much like the networking industry’s vendor financing, such market-distorting inducements make it tough to gauge real demand – even if the carmakers can boast of better results than, say, the producers of networking equipment.

Other companies, though, were able to use a sound forecast as an intellectual framework for smart decision-making. Eaton Corp., with $8 billion in annual sales and products that range from truck transmissions to circuit breakers for homes, started getting cautious when Adrian T.Dillon, Eaton’s chief financial and planning officer, warned of an impending: “short, sharp shock” in the economy.

Dillon’s insight did not save Eaton from the consequences of the downturn; no forecast can do that. But it did allow the company to cushion against the coming drop. As demand for its products shriveled, Eaton halted a stock-buyback program to save cash and pulled the plug on a couple of planned acquisitions. Although this year’s first-half earnings have plunged by 64%, the decline could have been steeper had the company not prepared its managers – and Wall Street – early on. In fact, Eaton’s stock is up 11%.

Fool’s Game. Sun Microsystems Inc. doesn’t rely on long-range forecasts in its purchasing but instead tries to buy supplies – often over the Internet – as needed. Its top operations and sales staffers meet weekly in supply-demand gatherings to make sure their work is balanced. And they try to ensure that their partners don’t get left in the lurch when demand moves south. Twice last year, Sun asked supplier Celestica Inc. to delay deliveries that Sun had ordered, but when it came time for Celestica to either take a charge for goods or deliver, Sun took them. “Sun treats suppliers more decently and they remember,” says Sun operations chief Marissa Peterson.

Regrettably for many in Silicon Valley, the ability to make accurate forecasts can depend on how well-established a company’s products are. Young industries on steep growth curves are almost always surprised by how well their poducts do in the first few years, and then they are taken aback when demand ebbs. Says Stanford University business strategy professor Kathleen M.Eisenhardt, “in a highly dynamic, ambiguous, and unpredictable market people are going to make mistakes. It’s inherent in the type of business.”

In many corners of Silicon Valley – and elsewhere – unpredictability is inevitable. One solution: keep innovating but develop sound service businesses to sell with products. “I break the world into two segments – one is creating demand and the other is servicing demand,” says Craig H.Muhlhauser, president of the cutting-edge power-storage systems maker, Exide Technologies. Building a “very robust service business,” he says, smooths out the rough spots between innovations.

No matter how well companies try to forecast demand, they will almost always be off the bull’s eye. Chaos is simply more the norm than orderly, predictable patterns. Indeed, Wharton School adjunct professor Paul J.H.Schoemaker argues that sticking too closely to a forecast is a fool’s game. Better to use scenario planning, in which you prepare to handle different sets of circumstances. “You can’t reduce the uncertainty, but you can manage it by having options,” says Schoemaker.

No business, of course, is recession-proof. But managers who understand that markets go down as well as up are a lot more likely to read the tea leaves correctly. Better to see the warning signs and ratchet down early than find yourself stuck with billions in equipment that suddenly no one wants. Just ask Cisco.

Business Week