Forecasting: Folly or Responsibility?

April 2021
Phil Ruthven AM, Founder & CEO

“Prediction is very difficult, especially if it’s about the future.”

So said Niels Bohr, a Danish Nobel laureate in atomic physics in the early 20th century. Economists trot out this quote perhaps more frequently than other forecasters; certainly, the late Gordon Bruns often did so during his tenure as the ANZ’s Chief Economist.

Alternatively, as American economist Edgar Fiedler famously – and wryly – offered , “If you have to forecast, forecast often.”

So, why do we bother? The most likely answer is that the only thing more risky or irresponsible than forecasting is to not try in the first place.

Some CEOs and Boards say the fast-changing world around us makes it virtually impossible to plan for the long term anymore. By their assessment, budgets and three-year business plans are difficult enough as is; anything longer-term, such as five-plus-year strategies, are pie in the sky.

The Institute’s analyses of corporations finds that such Boards are usually running businesses way below world’s best practice (WBP) performance and profitability (being a 22%+ return on shareholder funds after tax, or ROSF). And, ironically, the same corporations are often investing big amounts of capital in new technologies and systems with ‘lives’ way beyond five or even 10 years; which amounts to strategic decisions by default.

Yes, forecasting and strategy are difficult, but they are doable. As we move further into the 2020s, we have enormous amounts of data and Digital Era technology (including Artificial Intelligence) available to help us plan from the outside in with a holistic appreciation of the real world outside our own corporation.

But only one in 10 of Australia’s largest corporations have cottoned on to this, compared with four in 10 US corporations; and it shows whether the company is private or listed on the ASX. Few get the long-term strategy perfect; but being alert to new factors or unexpected developments is reason enough for finetuning or – at worst – revision. Anything less could be a breach of governance.

The COVID-19 pandemic was one such unexpected development in 2020, but it should not have been received as such. After all, pandemics can – and do – surface often enough as is. However, the world at large was ill-prepared for a pandemic of this scale; and governments worldwide responded with large-scale economic shutdowns and record peacetime deficit spending.

Nations cannot afford to handle future pandemics that way, without going broke in the process. So, forecasting can (and should) lead to governments implementing more robust preventative and coping measures to avoid economic shutdowns of the type we have had with the COVID-19 pandemic.

Too many nations went into the pandemic with dangerous levels of debt, be it government (national) debt, corporate debt or household debt. (Or, more scarily, all three.) Record-low interest rates have mitigated further government debt – and, in Australia, household debt (via mortgages) – for a few or several years, but not indefinitely.

Fortunately, corporate debt is not a serious problem in Australia; but good forecasting and successful strategies is still rare among the nation’s businesses. While long-term forecasting is never easy, the following examples show it is not impossible if we follow the adage that ‘the trend is your friend’.

Let’s begin with the share market. Using an annual percentage change approach, the below chart suggests wild volatility and unpredictability: an observation with merit on a year-to-year basis, and even over a period of five to 10 years. But the chart further below uses the same base data and, for a long-term thinker, is reasonably predictable.

Comfort with forecasting requires us to consider how much data we have available (hint: we need lots of it), how it is presented, and how far ahead we are prepared to think. In the case of corporations, boards are being asked to plan further ahead than they have been for several decades.

A similar set of comments applies equally to how we view Australia’s economic growth, as seen in the following two exhibits. The economy’s volatile year-to-year growth came to a halt after the Agriculture industry shrunk as a share of GDP to less than 10% (now around 2%), thereby diluting the overall impact of seasonal weather conditions and international prices on a now-tiny industry. When we examine the longer term, however, as suggested by the second chart below – what’s the worry?

That said, the publication of the quarterly National Accounts generates lots of interest and speculation about where the economy is going; but rarely do the predictions go beyond five years and into the strategy arena for corporations. On first sight, it appears volatile.

But if we take a longer perspective, we can use a number of trends in the below chart to inform our strategic thinking, at least in a contextual sense; not the least of which are the long business cycles averaging eight-and-a-half years, as evident in the following exhibit.

Back to the above chart:

  • Our economic growth trend has been trending down since the late 1960s, when the Infotronics Age of services and ICT displaced the previous Industrial Age;
  • Productivity growth has slowed, as the services sector requires different tools and innovation compared with goods-based industries (manufacturing, construction and utilities), and these new tools are still being developed;
  • Our economic growth has slowed from 3.5% p.a. in the Industrial Age to below 3% over the past 15 years, due to inadequate innovation expenditure, poor productivity growth, and negligible reforms in labour, government, taxation, and energy;
  • The economy operates in cycles of around eight-and-a-half years, with a recession prone to occur at the end of each business cycle (but avoidable if capital expenditure does not fall below minus 9% growth in those vulnerable years); and, finally,
  • Since the onset of the COVID-19 pandemic, we and other nations are propping up the economy with massive deficit spending; with some nations already deep in debt to begin with. This cannot be an ongoing solution, especially as interest rates rise again.

In short: are we prepared as Boards, CEOs and C-suite executives to think, plan, and strategise over a longer term of five, 10 and 15 years? Our businesses did that in the 19th century with agriculture, mining, manufacturing and utilities; and our GDP growth – admittedly helped by fast population growth – averaged over 8% p.a. (real) as a result.

In the 20th century, we slowed to less than half that growth rate; although protectionism did not help in that regard. And now, as the 21st century unfolds, we are on a path to halving that growth rate again.

To combat this, we need vision, longer-term planning, innovation and winnable strategies at the government and corporate levels.

Forecasting isn’t folly. It is a condition of survival for individual corporations and the nation at large; and it is a responsibility as well as a marker for good governance.

The techniques for forecasting – which we only lightly touched on in this Insight – can be applied to one’s own industry and the complex external business environments to confidently plan for the long term, develop successful strategies, and ultimately achieve WBP profitability.

What a thrill it would be to see four in 10 Australian corporations achieving WBP profitability, just as they do in the United States.

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