The Fantasy of the Long Term Business Case
In most companies, any large capital investment, whether it’s a large organic build or an acquisition, requires a fairly detailed business case that includes long-term financial projections. Some companies run the projections out for a defined period of time (often 5-10 years) while others dictate that the projections run through and past the point where the investment pays back. There are different measures of return on these investments including payback, IRR, scale and/or growth targets. Some of these financial models are incredibly detailed “bottoms up” projections while others are more high-level views based on a limited number of driving assumptions. But one thing is true of all these financial models. They’re wrong. Totally off…..and usually off by a lot. One reason is that the folks building these models are not psychic (presumably if they were they would be enjoying their gambling winnings on a yacht not neck deep in a 10-sheet Excel spreadsheet). Changes in competitive, customer, market, and other external dynamics are very hard to predict even roughly over a 5-10 year period to say nothing of internal changes within an organization including failures to execute, changing priorities, and approaches.
Beyond the unpredictability of the future, there is also a complex mix of adverse incentives and biases pushing into that model. Some contributors are trying to reverse engineer a result that will justify the investment they want to make while others may be sandbagging the numbers to make sure they can overachieve. Others may have inherent biases toward greater focus and investment in areas they understand or own (the old “if you have a hammer, everything is a nail” chestnut).
The net result is basically a somewhat well-informed guess, then warped and twisted by biases. Potentially more accurate than a random throw at a dartboard but far more dangerous because it is presented (usually with unreasonable levels of precision) as a highly accurate projection creating a very false sense of security.
So why do we take so much time and effort to build business cases and financial models that are almost always totally wrong? A couple of thoughts. First, some people have not accepted the notions above and believe that these financial projections are far more accurate than they are. But I would hope that fairly well-informed business executives who have watched many business cases come and go have long since given up that conviction. And I count myself among them. But I am still a big advocate of thoughtful business cases and financial models. Why?
A well-thought-through business case and financial model process forces the business leaders who will own execution to think through a myriad of issues in more detail. Just by virtue of having to put down numbers on paper, they are forced to think about product features and functionality, competitive environment, sales process, pricing, staffing, and a number of other critical issues. They need to think through these issues and hopefully challenge their own thinking not only to come up with the numbers but to be able to defend their choices to leadership. Having well-thought-through answers creates the credibility they need to get the business case approved. And even if the business case is totally off, you have better prepared the business team to execute their plan and avoid at least some pitfalls.
The business case also provides a benchmark for reward and punishment. Business leaders are judged against it to assess performance. You might say that’s totally unfair since we’ve established that it’s likely to be inaccurate. But the alternative is much worse. In the absence of some benchmark, we have no way to motivate the business owners. The best way to deal with this conflict – in my view – is to recognize that “re-plans” will be a reality of most business cases and that every couple of years you will need to revisit the business case and adjust expectations for the realities of the business and the market. But by doing this at the leadership level you ensure that the business owner is held at least somewhat accountable – they’re let off the hook but only after they convince leadership that their decisions have been sound and the shortfall is due to reasonably unanticipated internal or external consequences.
So when you build your financial plan I would keep these things in mind:
The journey is more important than the destination. Dig into HOW and WHY you will achieve those numbers.
Use the business case to have an ongoing discussion about the business rather than just a mathematical monitoring tool
Recognize that it’s likely wrong and expect the business to diverge from the case. That’s not in and of itself, a failure but is a reason to have the business owner do a deep dive into why there is divergence and how (if the divergence is negative) she can mitigate.
Don’t lose the forest for the trees. False precision may seem comforting but adds no value and often distracts. For every component of the model, ask yourself how strong your data is to support the assumptions – the weaker the data the higher level I’d leave the assumptions.
Nothing replaces clear business accountability. A detailed model with no (or too many) throats to choke is a very expensive coaster for your coffee cup.
Good luck on your next business case and don’t forget to budget for the celebration dinner….you’re worth it.
