The problem with projections
"There's a lot of air in that soufflé," I heard someone say recently.
I can't quite remember in what context — maybe it was from a cooking show — in any case, I thought the analogy fit well in summing up the problem with projections these days — too much air, not enough egg … em, data.
Over-inflated projections based on assumptions rather than data leads to ill informed decisions.
For entrepreneurs and investors, the problem with inflated projections (usually made for pitches) is that they come to be adopted, adding unnecessary and unrealistic pressures and stress to an already difficult to make concoction. And we didn’t start out to intentionally inflate the numbers but as assumptions are made – the hopeful ones – the numbers get out of control.
Attempting to meet unrealistic targets is a fool's errand, one that not only hurts the company, founder and investors but the community, consumer and economy as a whole. If the aim is to increase short-term returns and long-term success, expectations need to be calmed down from where they are today.
Founders get funded by making their companies look and seem attractive. So what makes a company attractive to investors? A passionate vision, brilliant idea, and sincere commitment are great but it is the numbers. Let’s be honest, it’s the numbers. The same underlying thing that mobilizes all people, everywhere — incentives. For investors, incentives are usually most enticing if they are the numbers presented in the form of high returns, even unrealistically high returns.
The real problem with projections is the assumptions we make in putting them together. Each assumption can be made so many different ways. If we change the assumed market penetration rate by a slight amount it can have profound effects on the projected revenues and profits. And the attractiveness of the investment.
Investors want to see hockey sticks! Picture this pitch, “so, the next three years we are expecting revenue growth of 20% annually and as we hit year four the market penetration will hit stride and we should see a doubling of sales. And the same for year five.” Sound familiar?
What are these assumptions based on? What air are we inhaling? And we believe them!
After identifying major competition within an industry, if a company's projected growth rate is higher than the industry average, an explanation of strategy leading to its exceptional growth rate needs to be formulated in order for any dollars to be allocated to this company on the basis of reality. How are you and where are you playing the game differently to account for that surge in market demand?
It must be emphasized, industry benchmarks must seriously be considered when creating market intelligence reports leading to final company projections.
Market intelligence reports should not only identify the best case scenario, they should be executed under three separate approaches,
- Realistic
- Worst case
- Hopeful
Each case should be thoughtfully considered.
The problems that arise when projections are exaggerated and left unquestioned are broad and many, but the most damaging of all is failure. Curiosity will not kill the cat here – it will most often save the day.
The reason why companies fail in the wake of exaggerations and overstatements is simple. There's nothing left to really achieve to.
If goals are not founded in reality, or in other words, are unachievable … well, I think you get the point.
Enter Theranos, the latest high-tech startup bound for greatness that fell short before realizing any of its goals.
After a 10-year long-con which amassed over $400-million and generated a valuation of $9-billion, Theranos and its secretive CEO Elizabeth Holmes went under the metaphorical knife for the first time, thanks to the Wall Street Journal and reporting by John Carreyrou.
The report poked holes in Theranos' story, casting a shade of doubt on the company's purported achievements. The report led to a total onslaught of the company and its founder.
Forbes, which before the scandal broke estimated Holmes's net worth to be $4.5-billion, revised their estimate to simply "nothing", in the wake of the news.
Even supposedly brilliant investors can buy the hype when a charismatic founder is at the reigns, no matter if the company in question is founded in fantasy and shrouded in secrecy and no due diligence has been ventured whatsoever.
Theranos is a benchmark case in believing the hype and will provide finer, more tempered business prudence for the investors who bought in or considered it, moving forward. The case is one of infamy.
The troubles faced by Theranos are not unique, however. Exaggerations and overstatements run rampant, and no matter how innocuous they may seem they all have the power to diminish returns, decrease the likelihood of success and even derail a company totally.
It bears repeating; if the aim is to really increase short-term returns and long-term success, expectations need to be calmed down from where they are today.
Projections need to be based on sound assumptions, with in depth scenario analysis to understand the strategy for winning. We need to test the numbers and assess a healthy set of expectations rather than inflating the potential. Investor expectations need to be realistic so we shape the business to win.
Amending these expectations along with re-visioning what a healthy, founder mindset is, embodies, for me, the simple, first-steps to improving the welfare of founders, our communities and the economy as a whole.