So Close Yet So Far: How Small Errors Can Have Dramatic Impacts

We've discussed before how "business plans are always wrong" in that there is no way to, with 100 percent accuracy, forecast the future. Unless you have uncanny luck, your forecast will always be off by a certain margin.

"The plan sets a marker," says Tim Berry, founder and chairman of Palo Alto Software. "Without it we can't track how we were wrong, in what direction, and when, and with what assumptions."

"Ninety-eight percent is pretty close to 100 percent, isn't it? Don't break out the champagne just yet."

Celebrations or Lamentations?

The key to successful resource planning is more than just understanding and accepting that you will be wrong — it's understanding how being wrong will impact your business. Even without considering devastating outlier events like Black Swan, every forecast has a margin of error built into it.

Say you reach the end of your fiscal year and you take a look back at at your forecast. You see that your forecast was 98 percent accurate to what actually occurred. Ninety-eight percent is pretty darn close to 100 percent, isn't it? Time to celebrate, right?

Don't break out the champagne just yet. Just because you were only off by a small margin doesn't mean that your business isn't in big trouble. Even a small forecast error can have dramatic implications for business results. This means understanding that the important thing isn't that you were only off by 2 percent, but what that 2 percent means to your business.

Low Profit Margins, High Risk

For industries where profit margins are relatively low, even a small margin of error could spell bad news. For a grocery store, getting demand wrong by even a few percentage points can have devastating results when it comes to product ordering. Overestimate demand even by one or two percent and you run the risk of wasting product through spoilage. Underestimate, and you could find yourself with empty shelves and angry customers.

"Such limitations mean that small businesses can seldom survive mistakes or misjudgments," writes John Welsh and Jerry White in The Harvard Business Review. While some industry models mean that certain businesses are insulated against the impact of error margins — an example might be how a tire manufacturer could offset slower-than-predicted sales into reduced production — those business poised on the edge of a fiscal cliff by small profit margins might only need a tiny push to fall into insurmountable debt.

Where Does The Journey End?

Think of a forecast as the course one might set for a cruise ship: Your business has a distinct destination in mind, and hundreds of nautical miles to cover before you arrive. One degree of error along the way could wreck havoc on your intended course and mean your journey ends in an entirely different place than you meant it to — in unfamiliar and potentially unfriendly waters. That's why it is of the greatest importance to not simply have a rock solid forecast, but to understand the ways that even minor inaccuracies impact your business.