Managing based on Assumptions
by Daniel Druwe Araujo
In the last decades the science of business management has gained relevance and developed a wealth of instruments. Of special importance are techniques focusing on the analysis of facts and data to make management more objective, precise and reliable. In spite of how much facts, data and analysis techniques are helping business managers, the essence of this challenging position is to make decisions for the future. While facts and data can be very useful to project the future, we cannot find facts and data but in the past.
With higher or lower uncertainty, the essence of business management is to choose the appropriate level of risk to make decisions. There are good techniques for identifying and managing risks in business but a full discussion of them is beyond the proposal of this article.
In here we will be discussing how assumptions can be instrumental for business managers in making decisions, deploying them and eventually reforming them as conditions evolve differently than expected.
We will also see that assumptions are especially useful when several people and functions are involved in making and implementing business decisions.
Why Use Assumptions?
Every statement or decision is based on assumptions even though, in most situations, we are not even aware of the assumptions behind what we say or decide.
The “5 Why’s” is one of the techniques that help to bring up the assumptions behind a statement or decision. People are many times surprised when asked “but why are you saying this?” or “why have you decided or done that?”. They may have to think for a moment before responding. As you ask a second, third or fifth “why”, they may even feel annoyed. Nevertheless, as people examine the hidden basis for their statements and decisions, they sometimes decide to revise them.
Just explicitly identifying the assumptions is enough to lead us to correct or to improve many of our statements or decisions. And, even when we do not change the original idea, we gain the benefit of a firmer conviction of the appropriateness of it.
By making assumptions explicit, we:
By forcing the explicitation of assumptions we improve the management of uncertainties.
By substituting assumptions for our ignorance of the future we are able to understand what we ignore, share it with others, obtain their contribution, assess their risk and impact, make contingency plans, monitor deviations, take proactive corrective actions and learn from the mistakes.
Examples of Assumptions
One of the most important processes for business management is what is commonly called the Sales & Operations Planning or, in its more advanced form, Integrated Business Management (1). This is a critical process because it provides the bridge between the high level strategic plans and the detailed operational schedules. The main output of the process is a set of aggregate level plans for the next 18 months, instructing the organization on product development, demand, supply, critical resources and financial results.
The Sales & Operations Planning / Integrated Business Management is one of the processes that most heavily depend on a good management of assumptions to work well. Three of the reasons why assumptions are so important in this process:
The Assumption Cycle
Phase 1 - Individual Managing based on assumptions ideally starts at the individual level, as represented in the flow of Fig. 1. Learning to challenge the assumptions hidden in one’s thought process significantly improve one’s proposed decisions and plans, providing the team with a superior starting point.
Decisions and plans, providing the team with a superior starting point.
Proposals with mistaken assumptions are revised and improved and the individual becomes better prepared to explain his/her “winning” proposals to the team with the underlying assumptions.
Phase 2 - Team Validation The analysis and validation of assumptions by a team is one of the most powerful bullet-proofing and improvement techniques. As indicated before, this is one critical element in a good S&OP / Integrated Business Management process. As an example, the proposed Demand Plans should be presented with the corresponding assumptions and risks, as opposed to the traditional “trust me, I know the market”. Similarly the proposed Production Plan needs to make explicit the assumptions necessary to make it happen. Yes, we can produce this much assuming that 70% of the volume will be in large packages. Well, this forces the Demand people to validate that assumption or correct it: “we are seeing a trend in the market to small packages for small households and we think the mix will go towards 50/50%”. With this change in assumption we’d better revise the Production Plan.
Instead of disputing “you never produced what you promised, why should I believe you now?”, the discussion changes to understanding the assumptions and the risks. This makes the proposals of each area more understandable to the others and offers a more positive terrain to pursue a consensual plan.
But Assumptions are a powerful concept and technique to be used in all business processes.
Phase 3 - Risk Analysis and Contingency Planning The assumptions behind a proposed decision or plan can imply very different levels of risks and impact. Decisions or plans based on high-risk assumptions may still be very attractive for the business but jumping to execution without appropriate contingency plans would be less than responsible.
Fig. 2 exemplifies how an S&OP team might analyze two assumptions, one on the supply side and another on the demand side of the chain, but both with wide impact on different stages of the value chain and on the financials of the business.
It starts with a clear description of the assumption, the decision and plan that were adopted and what is expected to happen if the assumption does not come true, including quantitative effects on volumes and financials.
The management team then agreed on the probability of that assumption realizing and on the impact it has on the decisions/plans adopted. The first example, of steel price increase, was considered an assumption with a medium probability of realization and a high impact, including cost increase, material shortage, decreased revenue and decreased margins.
The management team decided to immediately make some hedge investments tied to the price of commodities and to advance supply contracts, accepting inventory build-up.
The Chief Financial Officer was assigned the responsibility of monitoring the realization of the assumption and triggering the contingency plans if based on market analysis, a steel price threshold and on indications of increased failures of supply.
Contingency plans included the importation of steel with consequent increase in product cost, the increase of the product price and the management of demand, implying prioritization of customers.
A similar process is applied to the second major assumption - the launch of a new product by a competitor.
Phase 4 - Execution In this phase the organization is not restricted to executing the decisions and plans made. An essential task in this phase is the monitoring of the assumptions that are critical to the success of those decisions and plans.
If any assumption tends to deviate, the person responsible for monitoring it will trigger the implementation of the agreed contingency plans.
Phase 5 - Improvement Similar to any PDCA cycle, the assumptions cycle also asks for continuous improvement based on the deviations. What is special in this case is the principle that deviations of assumptions are the most likely cause of deviation of results.
Two of the important questions in this phase are:
Obviously the next question is “how can we improve the identification of assumptions and the application of contingency plans in future cycles?”.
At first, following the assumptions cycle makes some people uneasy. “Why should I have to explain to the other guys the reasons for the plans of MY area?
Why don’t they trust my functional competence and responsibility?”. The assumptions cycle is heavily critical of the old functional silo culture - “mind your own function”.
However, as people experience the benefits of bullet-proofing decisions and plans, getting prepared for deviations and, especially, of a holistic approach to the business, resistances are being replaced by adherence to the model.
The Vertical Dialogue
One of the most common complaints of people in the organizations is that management imposes unrealistic objectives and plans on people. The complaint is many times justified but it is also true that subordinates can do a much better job on their side.
First of all, when subordinates submit their proposals for budget, sales plans or annual objectives, it can help both parts if the assumptions for them are very clear. Yes, we can sell this much assuming these marketing and commercial actions, the availability of these products with a certain level of performance, or this number of sales people.
This helps the proponents by forcing them to validate the logic of the proposal. It also helps management to understand what is behind the proposed numbers.
If management decides the proposed numbers should be changed, there is a chance that they will indicate which of the assumptions should be changed to support the new numbers.
If management does not indicate the assumptions that should be changed, it is up to the subordinates to go back explaining: “yes, we can do the new numbers however these are the assumptions that we need to change to make the new numbers feasible”.
Sounds too good to be true? I bet yes. In many cases management may say “I don’t care for the assumptions, these are the new numbers and you will do then because we are saying so”.
But I like to believe in two more positive things:
Here are some characteristics that prevail in modern business management:
Assumptions are instrumental to all of these characteristics. As explained, they tremendously help the different functions and organizations focus on the logical basis of the decisions and plans rather than fight to defend their functional interests.
Assumptions help empowerment and agility because they are a very convenient middle term between detailed prescriptive procedures and blank checks.
And Assumptions are very helpful in understanding the cause of deviations and what can be done better next time.
There are several attempts to define excellence in business management. One of the classical ways is the Class A Checklist for Business Excellence, maintained by the Oliver Wight Companies (2). Assumptions are one of the critical elements in the Class A culture and processes, especially in Demand Management and in S&OP / Integrated Business Management.
In a world of uncertainty and constant change, Managing Based on Assumptions is a very useful instrument for the modern manager.
(1) Enterprise Sales & Operations Planning, George E. Palmatier with Colleen Crum, J.Ross Publishing / APICS
(2) The Oliver Wight Class A Checklist for Business Excellence, Sixth Edition, John Wiley & Sons
Resumo em Português
Gerenciamento Baseado em Premissas
Nas últimas décadas a ciência da Gestão de Negócios ganhou relevância e desenvolveu um bom conjunto de instrumentos. De especial importância são técnicas focando na análise de fatos e dados procurando tornar o gerenciamento mais objetivo, preciso e confiável.
A despeito do quanto essas técnicas de análise e os dados e fatos têm sido úteis, a essência do gerenciamento de negócios é tomar decisões para o futuro. Embora dados e fatos sejam úteis para projetar o futuro, eles sofrem da grave restrição de somente existirem no passado.
Com maior ou menor incerteza, a essência do gerenciamento de negócios é a escolha do nível de risco mais apropriado para cada decisão. Existem boas técnicas para identificar e gerenciar riscos no negócio mas uma discussão completa do assunto vai além da proposta deste artigo.
Este artigo expõe como as premissas são um instrumento valioso para a tomada de decisões de negócio, a sua implementação e mesmo a sua modificação conforme as condições desviem-se das originalmente planejadas. As premissas são ainda mais úteis quando as decisões e sua execução envolvem muitas pessoas e funções.