How should economic forecasts inform next year’s business plan?
Growth forecasts in 63 countries often missed the depth of recessions. Use ranges, scenarios and scheduled assumption reviews to incorporate economic forecasts into business plans.
How should economic forecasts be used in a business plan?
The numbers in an economic outlook report are a starting point for a business plan, but are too uncertain to serve directly as the basis for sales targets. A study of growth forecasts across countries found that forecasts substantially missed the depth of recessions until the year was nearly over. Treat forecasts as ranges rather than single estimates, agree responses in advance for baseline, pessimistic and optimistic scenarios, and review assumptions each quarter.
How accurate are economic forecasts?
A study of GDP forecasts for 63 countries between 1992 and 2014 (An, Jalles and Loungani, 2018) tracked how forecasts changed ahead of recessions. Forecasters generally recognized that recession years were different from other years, but substantially missed the depth of the downturn until the year was almost over. Forecast revisions were slow in normal periods. Revisions accelerated in recession years, but not enough to avoid large errors. If the business plan remains unchanged while the forecast received at the start of the year is gradually revised, recognition of the gap between the plan and actual conditions is delayed accordingly.
The researchers also reported that strong booms were missed. This finding is consistent with the interpretation that behavioral reluctance to absorb either good or bad news influences forecasts. For business planning, the more important lesson is not simply that forecasts are wrong, but that they can be slow to adjust in a particular direction.
Would combining forecasts from several institutions be better?
The same study found that private- and public-sector forecasts were virtually identical and equally unsuccessful at anticipating recessions. Forecasts based on similar information and methods can all be wrong in the same direction. Increasing the number of forecasting institutions does not necessarily broaden the range of judgment.
Rather than merely collecting more forecasts, examine whether they come from different assumptions. Record the assumptions behind variables that directly affect your business, such as exchange rates, interest rates and demand in key markets. This makes it easier to identify what changed when a forecast is revised. Read the risk factors and conditions in the body of each report as well. The circumstances under which the figures would change, rather than the figures alone, provide the material for scenarios. Companies dependent on overseas demand should also consider forecasts for their major export destinations.
What distinguished better forecasters?
In a two-year geopolitical forecasting tournament, a research team (Mellers and colleagues, 2014) improved accuracy through three approaches. Probability training addressed cognitive biases, encouraged reference to outcomes in comparable groups of cases, and taught techniques for averaging multiple estimates. Teamwork allowed forecasters to share information and reasoning. The researchers also formed elite teams from the top 2% of first-year forecasters. All three approaches improved accuracy, leading the researchers to conclude that behavioral interventions, as well as statistical methods, could improve forecasting.
These approaches can be adapted by business-planning teams. Express sales forecasts in probabilities rather than a single number, have departments share their reasoning, and record the accuracy of previous plans to inform the next one. Simply writing down each department's gap between last year's sales forecast and actual sales can reveal a recurring direction of error. Collecting individual estimates in writing before pooling them in forecast meetings helps prevent one person's voice from dominating.
What are the options for incorporating economic forecasts?
Comparison of ways to use economic forecasts
| Approach | Strengths | Limitations | Suitable situations |
|---|---|---|---|
| A single forecast | Makes targets and budgets easy to set | The whole plan is vulnerable if the forecast is wrong | Businesses with little exposure to economic cycles |
| An upper and lower range | Makes uncertainty visible in numbers | Does not specify what to do within that range | Deciding budget headroom |
| Scenarios | Allows responses to be agreed in advance for different conditions | Takes time to prepare | Businesses sensitive to economic cycles and exchange rates |
| Signal-based switching | Supports rapid responses to changing conditions | Requires someone to monitor signals continuously | When investment timing can be adjusted |
The approaches can also be combined. For example, build the budget on the baseline scenario but decide investment spending in stages according to signals.
What should be decided for each scenario?
Scenario planning means agreeing what to do in different circumstances, rather than merely preparing three sets of figures.
Examples of decisions to prepare for each scenario
| Scenario | Example assumptions | Signal to switch | Response to agree in advance |
|---|---|---|---|
| Baseline | Demand in the main market remains at the previous year's level | Monthly orders stay within the planned range | Proceed as planned |
| Pessimistic | Demand slows while costs rise | Orders decline for two consecutive months | Hold hiring and equipment investment; reduce inventory |
| Optimistic | Demand recovers faster than expected | New inquiries and repeat orders surge | Set the sequence for securing additional production capacity |
Signals are more usable when based on internal indicators the company can review monthly. Official statistics may be published too late for timely decisions.
Read preparation for interruptions under a pessimistic scenario alongside business continuity planning. For a meeting method that assumes a plan has failed to identify weaknesses, see reducing judgment errors in management decisions.
When should forecasts and assumptions be reviewed?
Each quarter, compare forecasting institutions' revisions with your company's actual orders and sales to assess which scenario conditions are approaching. Use the review to improve the forecasting approach for the following year's plan. Also decide in advance who determines that a scenario has changed. Exchanges with other owners about business conditions can sometimes provide earlier signals than official statistics, as discussed in the effects of business-owner peer groups. The Korea Research Institute of Business & Branding publishes Business Insights, analyzing the business environment and major issues, and Future Business Briefs, exploring emerging changes and opportunities. See business publications and reports for publications and management strategy advisory for medium- and long-term strategy reviews.
Frequently asked questions about economic forecasts and business planning
Which institution's forecast should we use as our baseline?
Instead of choosing one institution, examine the range across forecasts and compare their assumptions. Private and public forecasts have sometimes made similar errors.
How many scenarios should we prepare?
Baseline, pessimistic and optimistic scenarios are the most common three. Agreeing switching signals and responses for each matters more than the number.
Should the entire business plan be rewritten if forecasts change substantially?
If scenarios have already been prepared, implement the relevant responses rather than rewriting the plan. If the change was not anticipated, begin by reviewing the assumptions.
Do small companies need scenarios too?
One or two pages are enough. Simply agreeing which costs to cut first if sales fall sharply, and which capabilities to expand first if sales rise, can speed up decisions. Prior agreement among managers is the key, even without a formal planning document.
References
- International Finance, “How well do economists forecast recessions?” (An, Jalles and Loungani), 2018. https://doi.org/10.1111/infi.12130
- Psychological Science, “Psychological Strategies for Winning a Geopolitical Forecasting Tournament” (Mellers and colleagues), 2014. https://doi.org/10.1177/0956797614524255