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Adaptive Insights held its annual user group meeting recently. A theme sounded in several keynote sessions was the importance of finance departments playing a more strategic role in their companies. Some participating customers described how they have evolved their planning process from being designed mainly to meet the needs of the finance department into a useful tool for managing the entire business. Their path took them from doing basic financial budgeting to planning focused on improving the company’s performance. This is one of the more important ways in which finance organizations can play a more strategic role in corporate management, an objective that more finance organizations are pursuing. Half of the companies participating in our Office of Finance benchmark research said that their finance organization has undertaken initiatives to enhance its strategic value to the company within the last 18 months.
We believe that presenting its software as an aid to make the planning process more strategically valuable is a product strategy that is essential for the long-term success of planning software vendors. It was a theme in Adaptive Insights’ recent release of its Adaptive Suite and revenue planning software.
Companies do many kinds of planning, not just budgeting. They plan sales, they determine what and how they will produce products or deliver services. They plan the head count they’ll need and how to organize distribution and the supply chain. They also produce a budget, which itself is a financial plan. The planning process involves discussions about objectives and the resources and tactics that people need to achieve them. Our benchmark research finds that dedicated applications are more effective tools for planning than are desktop spreadsheets (which nevertheless are still the most widely used technology for planning). For example, dedicated planning software is more able to get to underlying causes behind variances immediately during a performance review meeting. Users can apply the information that’s in the application when reviewing results and adjusting goals and objectives to reflect changes that have taken place in the business. The research shows that organizations that use dedicated software more often can get to the underlying details of the difference between plans and actual results and therefore are more able to make fast decisions about what to do next. Spreadsheets are inherently less capable of drilling down into underlying details.
Adaptive Insights has a suite of planning, analysis, reporting and consolidation applications that mirror the evolution of the business planning category. I coined the term “integrated business planning” more than a decade ago to describe an approach to planning that brings together financially focused budgeting and forecasting activities with various stand-alone functional planning efforts. The objectives of this approach are to provide senior executives with a comprehensive view of future expectations for their business; to set a baseline for performance measurement; to assess performance relative to these baseline objectives; and to periodically adjust objectives and resources in a coordinated, strategic fashion as conditions evolve. Integrating the business planning activities of the various functional groups within a company is best accomplished by providing a single planning environment in which each group can plan its part of the business the way it prefers, compare its actuals to plan using preferred analytical methods and easily report and communicate results within the group. Each planning process can be loosely coupled in that the cadence, items, measures, dimensions and other planning elements fit the needs of that specific part of the business. At the same time, because all planning takes place in a single environment, it’s easy to bring together the necessary information from each of the individual business unit plans to create a consolidated, forward-looking view of the company. It’s also easy to provide control and consistency across planning units by ensuring, for example, that all plans use the same projected benefits costs, commodity prices, exchange rates and other elements that will affect all parts of the organization. Our benchmark research on next-generation business planning finds that companies that integrate their planning by directly linking plans get better results: Two-thirds that have direct links said they have a planning process that works well or very well compared to 40 percent that copy and paste information and just one-fourth that have little or no connection between plans. Well-executed planning is the best way to get everyone onto the same page to ensure that the company is organized in executing the plan. Setting and to a greater degree changing the company’s course require coordination. It enables understanding of the impact of the policies and actions in one part of the company on the rest of the company. Information technology has the potential to make business planning more useful, and to help improve a company’s performance and increase its competitiveness.
From a financial management standpoint, it’s essential to be able to project pro-forma balance sheets and cash flows. When all operational planning is feeding the core business model, the future state of a company’s balance sheet and cash flow can be more realistic than when it is only loosely connected. Moreover, it’s possible to quickly and accurately compare the impacts of various operating scenarios on the company’s finances, assess the impacts of various financing alternatives and project how different capital market conditions will affect the company’s overall financing costs across multiple operating scenarios. All of this is possible using spreadsheets, but doing so is far more time-consuming (and therefore impractical) and potentially much less accurate.
Another reason why a dedicated planning application a better planning environment than desktop spreadsheets is that it facilitates the separation of planning into things and the financial aspect of those things: a unit-times-rate structure. While financial planning focuses on money, the rest of the business plans mainly in terms of things: units produced, head count at various pay grades, tons of raw materials and production yields, to name just a few. Having the ability to model units and currency amounts separately makes it far easier to measure performance in ways that are meaningful to each part of the business. In its most simplistic form, it helps planners determine immediately and unambiguously whether variance between the plan and actual results was driven by units, a price or cost variance or both.
Our research on enterprise use of spreadsheets shows that companies that use spreadsheets for forecasting, planning and budgeting usually spend much more time in analyzing and reporting results than users of more appropriate tools do. Dedicated software automates this process, enabling finance departments and other functional units to spend less time on repetitive tasks while providing accurate and consistent information to executives and managers. Adaptive Insights recently added to its suite Office Connect, which facilitates creating and updating reports in Microsoft’s Excel, Word and PowerPoint applications, enabling departments to operate more efficiently and speed the availability of performance reports. For example, using the software, standard monthly tables and charts can be instantly updated each month to speed the production of spreadsheets, narrative reports or presentation decks for monthly board meetings.
I have long advocated the use of dedicated planning applications rather than desktop spreadsheets for handling planning processes. The inherent technology limitations of spreadsheets make them a poor choice because they consume time needlessly and prevent organizations from being able to forecast, plan, analyze and replan effectively. Yet spreadsheets remain the leading technology used for planning. Our recent planning research finds that, across 11 different types of business planning, on average seven out of 10 companies use spreadsheets. I recommend that all midsize and large companies consider replacing spreadsheets with a dedicated planning application that provides a unified environment for planning across the entire enterprise. Midsize companies and midsize divisions of large enterprises should consider Adaptive Insights for this role.
Robert Kugel – SVP Research
Managing prices has always been an activity of keen interest to businesses, but it has become even more critical to do it well. Over the past decade many companies have found their ability to raise prices has been constrained by intense competition resulting from Internet commerce, global competition and other factors. One tool for dealing with this pressure is price and revenue optimization (PRO), an analytic methodology that calculates how demand varies at different price levels and then uses that algorithm to recommend prices that should optimally balance revenue and profit objectives. Computer-supported PRO began in earnest in the 1980s as the airline and hospitality industries adopted revenue management practices in efforts to maximize returns from less flexible travelers (such as people on business trips) while minimizing the unsold inventory by selling incremental seats on flights or nights in hotel rooms at discounted prices to more discretionary buyers (typically vacationers). Price and revenue optimization algorithms are designed to enable a company to achieve fatter profit margins than are possible with a monolithic pricing strategy. Using PRO, airlines and hotels catering mainly to less price-sensitive business travelers found they could match discounters’ fares and rates to fill available seats and rooms without having to forgo profits from their high-margin customers.
PRO has expanded into other industries as computing power and data storage become ever less expensive, as software vendors have improved their techniques and algorithms to deliver better results and as the software has grown increasingly user-friendly. While the concepts underlying all PRO software are the same, there are different categories in which it is customized to meet the needs of specific industries. Retailers in particular have requirements that are best met by using applications that manage markdowns.
At the heart of price and revenue optimization is the concept of demand-based pricing. As its name suggests, demand-based pricing is a method that sets a price that is controlled by the seller’s assessment of what the buyer is willing to pay, which in turn is based on an estimate of a good’s or a service’s perceived value to the buyer. Companies use demand-based pricing to optimize – rather than simply maximize – their pricing to achieve revenue and profitability objectives. It uses data to estimate where the prospective buyer sits on a demand curve and therefore how much the individual is likely to pay. In some respects this is similar to what happens daily in souks, bazaars and other markets in cultures that do not insist on set prices. However, software makes demand-based pricing practical in large businesses and facilitates its introduction in societies used to set pricing.
Advanced analytic applications – especially for price and revenue optimization – have been gaining ground in corporate management because they have demonstrated to work. Significantly, they have the ability to deliver results that are unobtainable otherwise. Such software can crunch through very large data sets rapidly, apply purpose-built algorithms and automate the repetitive mechanical steps needed to put decisions into action. It also ensures consistency and supports objectivity in how executives and managers make decisions. Price and revenue optimization applications have benefited as the cost and complexity of the computing resources needed to use them have declined.
The adoption of PRO software is part of a broader trend of using applications to support fact-based decisions that once depended on experience and hunches. However, our benchmark research on the Office of Finance finds that just 20 percent of companies use price optimization analytics extensively. Only one-third look at product profitability. We think that more of them should do both. Analytic applications can digest a considerable amount of data to segment markets into useful groupings, pinpoint correlations and divine trends, to name a few tasks necessary for pricing management. However, companies investigating PRO software should narrow their search to applications that are appropriate for their specific business. While some offerings have broader applicability than others, no software product now available performs well in every industry.
Retail businesses that have multiple outlets, especially those that deal in trend- or fashion-driven products, face unique price and revenue optimization challenges and this affects the design of pricing management applications aimed at retailers. Many of these businesses are self-service, exclusively so if they are Internet-based, so there is no face-to-face contact during the product selection process. Negotiating prices isn’t feasible in most multiple-outlet retail settings in developed economies because of cultural norms and the hazard of delegating these decisions to front-line staff in even a midsize company. Unlike business-to-business transactions that involve ongoing relationships with established products, most stores today know little about most of their customers, so there is no direct way of judging an individual’s price sensitivity for the specific purchase at hand. In other words, most of the elements that support PRO strategies in analytics used for other types of businesses aren’t available to multiple-outlet retailers.
Since they usually cannot gauge the price sensitivity of their customers, retailers take a different approach: Let the merchandise do the talking. Products that aren’t selling well are by definition overpriced in that market. Retailers have used markdowns as a crude tool of price optimization for a long time. Offering a 30 percent discount near the end of the season is usually better than having to take a 60 percent haircut from a close-out specialist. Yet deciding when and by how much to reduce prices and then implementing the reductions at the store level in an optimal fashion is complicated because of the number of variables that must be considered. There are different types of merchandise, including long-life categories of goods that can be offered for sale for years, short-life fashion and fad items that are offered only once and those somewhere in between. There are differences in demand patterns and price sensitivity between regions and even at the store level. Seasonality, weather and movable holidays such as Easter and Thanksgiving must be considered.
Using analytic applications is superior to relying on experience and intuition because applications often demonstrate that the best decisions go against the grain of established practices. For example, retailers have found that smaller markdowns applied earlier and more frequently produce better results (that is, greater volumes sold at a lower aggregate markdown) than the common practice of making one or two big moves. Until the data became available, minimizing the number of markdowns was reasonable because of the cost in staff time to change prices at the store level. However, retailers using smaller and more frequent markdowns more than pay for these costs and then establish processes to facilitate price changes. Some retailers have found to their surprise that early small markdowns reduce the overall cost of markdowns. Analytic applications also are able to deal with a range of variables that retailers can use in markdown management. For example, they can vary percentages and frequency by size and color as well as by location. The software can monitor sales and inventory levels by the SKU at each store and automatically make detailed recommendations on how to adjust pricing. The software also enables retailers with multichannel operations (usually an online presence) to manage pricing decisions optimally across different types of outlets.
PRO software designed for markdown management also enhances the ability of a multiple-outlet retailers to run their business in a way that maximizes the productivity of their stores measured in sales or gross margin per square foot (or meter) or per linear foot (or meter) of shelf space. Items taking up space in a store or on a shelf have an opportunity cost in that they could be replaced by faster-moving or more profitable goods. Modeling the cost of the uplift required to free up space can result in a more attractive mix of merchandise that will improve returns.
While usability and capability of markdown management software have been improving, retailers face internal challenges in being able to utilize it. Analytic applications are only as good as the data available to feed the systems. Our research consistently finds that data accuracy and availability are significant challenges that almost all midsize and large companies face. Using markdown management software successfully also involves a change management effort requiring heavy involvement by senior management to endorse changes in how the organization handles day-to-day business as well as changes to processes and training and considerable amounts of follow-up to ensure compliance with the new ways of doing business.
Information technology is playing an increasingly important role in how companies conduct their businesses. Analytic applications can transform how entire industries operate. Today, airline and hospitality businesses operate very differently from how they ran in the 1980s because of the Internet and analytics. All sorts of businesses are finding that price and revenue optimization software enables them to improve their results measurably. Retailers should look into markdown management software as a way to fatten their bottom line. Other types of businesses also should consider PRO tools as applied to their particular needs.
Robert Kugel – SVP Research