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Applying Probability to Improve Business Performance Helping Companies Look Forward

Originally published April 18, 2007

During one of the more memorable scenes from the classic 1967 film The Graduate, a young Benjamin Braddock (Dustin Hoffman) has a welcome home party thrown for him by his parents to reintroduce him to their suburban community and adult friends. While trying to help Ben create clarity for his professional future, one of the party attendees, Mr. McGuire, shared a bit of advice:

Mr. McGuire: I just want to say one word to you – just one word.

Ben: Yes sir.

Mr. McGuire: Are you listening?

Ben: Yes, I am.

Mr. McGuire: Plastics.

Ben: Exactly how do you mean?

Mr. McGuire: There's a great future in plastics. Think about it. Will you think about it?

Ben: Yes I will.

Mr. McGuire: Shh! Enough said. That's a deal.

Although intended to be tongue-in-cheek humor in the late 1960s, few moviegoers realized how much of a soothsayer that Mr. McGuire was at that time.

Today, enterprise software professionals continue to mull over what capabilities they can add to their products both to create more value for their customers and to identify unique differentiators that allow them to compete more effectively versus their competition. If The Graduate was recreated in the year 2007 and the working professional had deep experience in enterprise software applications to help improve business performance, it is likely that the one word that would have a great future would be probability.

The application of probabilistic models to help address business problems is nothing new, but the breadth of understanding of these models, and the ability for non-mathematicians to apply them to help tune both financial and operational performance, is coming of age.

Professor James Smith of Duke University’s Fuqua School of Business says, “From an academic perspective, predictive models have advanced both in terms of accuracy and flexibility, and these technologies can now be applied to a wide variety of business forecasting problems. It is clear that these technologies have the potential to have a tremendous impact on day-to-day financial and operational decision making.”
 
"For example, imagine a system that not only provides a forecast of demand for your product next month, but also describes the uncertainty associated with that forecast,” Smith continues. “You can then make manufacturing and other decisions with a clear understanding of the associated risks: What is the probability that I will not have enough inventory to meet this demand? What is the probability that receipts from these sales and current cash balances will be sufficient to cover this month's expenses?"

Several performance management vendors have been touting the application of this type of mathematics in their applications with varying degrees of success. In its simplest form, predictive analytics provide a platform for a business user to help him feed historical information and key business drivers into a financial model and use that model to help define a range of future performance with a probabilistic degree of certainty. Although not the crystal ball that many execs would dream to have, this approach has significant advantages over the traditional review of historic financials and applying x% growth when considering future business forecasts and budgets.

On an operational level, companies are applying this type of analytics in both the sales and marketing department, as well as with human resources. In the cellular communications and credit industries, customer churn has always been a topic that executives recognize as the driver for success. The companies that could better identify potential customers who were considering defecting to a competitor could have the opportunity to take steps to ward off that defection. Several banks and cell phone carriers apply sophisticated models to help identify early signals of waning customer satisfaction or cost sensitivity – and take proactive steps to retain those clients. Forward-thinking human resource departments are also using these predictive capabilities to identify valuable employees who may be at risk. Assuming there is an interest in retaining an “at risk” employee, managers can take proactive steps in terms of enhanced communications, compensation and/or promotion to help assure that the employee stays focused on the job at hand.

In summary, predictive capabilities continue to evolve, and there are technologies now available that do not require an advanced degree in mathematics to apply to pressing business issues. For companies that are ready to proactively embrace this next stage of performance management, they will likely find themselves with an advantage over their competitors who rely on the more traditional approach to financial and operational planning.

  • John ColbertJohn Colbert
    John, Vice President of Research and Analysis at BPM Partners, is responsible for market trend analysis, services development and technology vendor relationships at BPM Partners, the leading independent authority on business performance management (BPM) solutions. Prior to BPM Partners, John was Senior Director, Product Marketing at Hyperion Software, responsible for directing Hyperion's OLAP Business Analysis financial software products. Earlier in his career, John was an end user of performance management solutions while a product manager at Raychem Corporation, a Fortune 500 company that has since been acquired by Tyco. John has contributed to many publications including the New York Times, BPM Magazine, Information Week, Business Finance and eWeek, and he is a regular presenter at performance management related conferences and web seminars.

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