There is often confusion between the sales and operations planning and budgeting processes. The root cause of the confusion is that traditionally, budgeting is done annually and is rarely if ever changed throughout the year. We have seen this most often in traditionally managed companies where the management team is operating against an unrealistic budget and does not understand the value of sales and operation planning. There may be a monthly review of the P&L where variances are discussed, but there is rarely a discussion about what the plan should really be taking the variances into consideration. Instead of recasting the numbers to ensure alignment throughout the company, they continue to trudge forward with the belief it will get better in some magical way.
Before we dig into the root of the confusion, for the sake of definition, the budget is a static time bound projection, usually done annually in advance of the coming fiscal year. It sets the sales plan and in turn the cost structure to meet the plan for the year. The sales and operations planning process comprises of a periodic demand and supply planning review where variances are identified and incremental changes are made to the plan as the year progresses. It includes a statistical forecast base (when available) and sales and marketing overrides that drive a related supply plan. We often call the sales and operations planning process your annual budgeting process done monthly on a rolling 12-month basis.
The critical point is that the incremental change to the plan does not mean the budget changes. Rather, it is a new line that shows the updated reality going forward. This is the source of the confusion. The budget, in most cases, will be the same number the year started with. The sales and operations plan will be a new projection that drives the company forward based on this new reality. Since sales and operations planning is usually updated monthly as a 12-month rolling projection, the budget becomes the starting sales and cost goal for the year, while the plan helps keep the business moving forward in response to changes. This, in turn, helps management proactively address unforeseen events not included in the budget that could affect cost and inventory levels. With each subsequent monthly update, a waterfall is created that shows how the plan has deviated from the budget over time. The variance of actual to plan and budget helps drive root cause analysis to minimize surprise going forward.
Sales and Operations Planning versus Budget in Football?
The easiest analogy to understand why the two are important and what they represent is to think of a football game. The head coach has a plan before the start of the game. He has a final score projected, let's call that the “budget” and the path to achieving the budget i.e. a mix of run and pass on offense and edge blitzes on defense. As the game progresses things will occur that were not planned (i.e., turnovers, injuries, and/or a game plan by the opposing team that was not considered). The head coach and his assistant coaches (the management team) often make small adjustments throughout the game. During halftime, depending on the success of the smaller adjustments, they make bigger tactical adjustments to deal with the variances to plan realized during the first half. Halftime is like the GPS for the team to get around the roadblocks and obstacles that are encountered during the game. Unlike GPS, where the new plan is automated, in football, the plan is reliant on human beings working together to understand the reality and adjust accordingly.
Bill Belichick, the head coach of the New England Patriots, recently made this point during one of his press conferences. He cited Dwight Eisenhower: “In preparing for battle, I have always found that plans are useless, but planning is indispensable.” His point is that ultimately good planning is important but more significantly the ability to adjust to what happens is critical. The inability to make these adjustments effectively could lead to a loss. That is why the most successful coaches are always prepared for the unforeseen and have contingencies in place to face the unexpected.
Business is no different. The value of sales and operations planning is that it provides a platform to make those tactical halftime adjustments on a periodic basis to help drive the team to meet or exceed the original goal (the budget). Managers can have a hard time with some companies adjusting their plan based on the latest information, particularly where actual is less than budget and investors are involved. The thought of adjusting the plan down is seen as a concession to failure as opposed to a means to gain control. The fear of driving the stock price down or alerting the bank is a deterrent to change. This a major obstacle to the progress of a sales and operations plan. If the team follows the budget regardless of what is happening around them, they are destined for a bad outcome.
When the sales and operations planning process is running the way it should, the variance between Plan and Budget, sets the stage for one of the key functions of the executive team, tactical and strategic planning.
Why is the distinction between Sales and Operations Planning and Budget a big deal?
If you never recognize and address the unexpected, you’re doomed to fail, which could result in excess and obsolete inventory! If you present the latest plan and there is a variance against the budget, the sales and operations planning process is the appropriate forum to resolve it. The management team, now aware of the variance, can form new tactics that can boost sales and recover the variance and ensure the supply plan follows. The byproduct of the new tactics is a new demand plan that could yield a number closer to the original budget, but with a realistic plan to achieve the end result with minimal risk to supply. There is clearly a major difference between the plan and budget. The budget serves as the base plan to which all subsequent plans are measured against. If the goal is to hit budget by year-end, the monthly sales and operations planning process is the half-time adjustment to help your team overcome the unexpected to guide you to meet or exceed the company’s year-end goal.
