The Drucker Difference

S&P and the Trouble with Forecasting


Very early in his career, when he was a 19-year-old trainee at an investment firm in Frankfurt, Peter Drucker ventured blithely into the world of forecasting. Stock prices, he proclaimed in a prestigious economic journal, were absolutely certain to keep going one way: up and up and up.

A few weeks later—in October 1929—the market crashed, helping to usher in the Great Depression. “Like so much of this work,” Drucker later recalled, “it proceeded from a self-evident assumption by means of impeccable mathematics to an asinine conclusion.…

The inability of human beings to peer into the future was cast into bold relief this week, after Standard & Poor’s downgraded the U.S. government’s credit rating—an assessment based in part on how much debt the nation is likely to have accumulated a decade from now. Critics immediately pounced on S&P’s penchant for making faulty predictions, citing the firm’s all-too-rosy ratings on mortgage-backed securities during the run-up to the financial crisis, as well as its lousy track record in foreseeing the fiscal health of countries across Europe.

“S&P’s bond ratings from five years ago would have told you almost nothing about the risk of a default today,” Nate Silver of the New York Times asserted in an extensive analysis. “In fact, the evidence … suggests that it may be worthwhile to adopt a contrarian investing strategy that specifically bets against S&P’s ratings.”

S&P’s Not the Only Blind Seer

In truth, as notoriously undependable as S&P’s crystal ball has been—and as complicit as it may have been in creating the housing bubble—S&P is hardly alone in having failed to prognosticate accurately. For instance, a recent report by the Pew Center on the States and the Nelson A. Rockefeller Institute of Government found that in 2009, half the states overestimated revenues by more than 10 percent, “starting a trend of unwelcome surprises.”

Nearly every private enterprise makes projections of one sort or another. Most are crummy at it. A survey conducted a few years ago by KPMG International found that a mere 1 percent of companies hit their financial forecasts exactly, and only about one in five comes within 5 percent in either direction.

That’s why Drucker, despite a reputation for having anticipated so many important developments (the Hitler-Stalin pact, the rise of Japan’s economy after World War II, the transformation from manufacturing to a knowledge age, the fall of the Berlin Wall) scorned forecasting.

“We must start out with the premise that forecasting is not a respectable human activity and not worthwhile beyond the shortest of periods,” Drucker wrote in his 1973 classic Management: Tasks, Responsibilities, Practices.

Building “Futurity” Into Decisions

Drucker called for corporations to focus instead on smart strategic planning. That’s an activity, he explained, that “does not deal with future decisions.” Rather, “it deals with the futurity of present decisions.”

“The question that faces the strategic decision-maker is not what his organization should do tomorrow,” Drucker wrote. “It is, ‘What do we have to do today to be ready for an uncertain tomorrow?’ The question is not what will happen in the future. It is, ‘What futurity do we have to build into our present thinking and doing, what time spans do we have to consider, and how do we use this information to make a rational decision now?’”

Managers should begin with a thorough look at current products, processes, and markets, and then ask themselves a very pointed question: “If we were not committed to this today, would we go into it?” If the answer is no, Drucker counseled, then that automatically raises another question: “How can we get out—fast?”

After this “systematic sloughing off of yesterday,” the next step is to ask: “What new and different things do we have to do, and when?”

Timing and Commitment, not Dreams

The “when” is especially complicated to get right. “In the expectations and anticipations of a business,” Drucker wrote, “the old rule of statistics usually applies that anything beyond 20 years equals infinity; and since expectations more than 20 years hence have normally a present value of zero, they should receive only a minimal allocation of present resources and efforts.”

There are, however, myriad exceptions to this standard. Lots of companies, Drucker acknowledged, have no choice but to plan well beyond 20 years. “If we know that it takes 99 years to grow Douglas firs in the Northwest to pulping size,” he pointed out, “planting seedlings today is the only way” to ensure an adequate pulp supply for the next century.

The real key, whether preparing for 10 years down the road or 100, is to get moving right away. “It is meaningless to speak of short-range and long-range plans,” Drucker declared. “There are plans that lead to action today—and they are true plans, true strategic decisions.”

On the other hand, he added, “there are plans that talk about action tomorrow—they are dreams, if not pretexts for nonthinking, nonplanning, nondoing. The essence of planning is to make present decisions with knowledge of their futurity. It is the futurity that determines the time span, and not vice-versa.”

Follow this advice, and you’re sure to be successful. I predict it. Guaranteed.

Wartzman
Rick Wartzman is the executive director of the Drucker Institute at Claremont Graduate University.

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