I lifted the following story from Grant Williams’s article from (John Mauldin’s “Outside the Box”) newsletter:
During World War II, [Nobel laureate, Ken] Arrow was assigned to a team of statisticians to produce long-range weather forecasts. After a time, Arrow and his team determined that their forecasts were not much better than pulling predictions out of a hat. They wrote their superiors, asking to be relieved of the duty. They received the following reply, and I quote “The Commanding General is well aware that the forecasts are no good. However, he needs them for planning purposes.”
In my white paper on Forecasting under Uncertainty, I made the point that there are no accurate forecasts about the future, whether made by banks, governments, businesses or other entities. Arrow’s quote would seem to apply to many business forecasts today.
If you need forecasts for planning purposes, it is more useful to consider a range of values around each factor that make up the projection. For instance, when projecting the revenue to be generated from a new product, there will be uncertainties around price, market share, market size, competitors, margins and other factors. The range may be considerable, particularly if you are entering a new market and less so where you have deep experience. Even in the latter case, one can never be 100% sure.
Since there is no such thing as an accurate forecast, the best you can do — and should do — is to provide a forecast that reflects the impact of uncertainty, indicating that your project NPV “could be as low as ….” or “could be as high as …,” clearly indicating that you have addressed unknowns and, if prudent, have developed contingency plans.
As addressed in the blog “Resolving Conflict and Confusion with Objectivity and Evidence” by Somik Raha, the “tornado chart” is a most useful tool in dealing with uncertainty.
