Why Use Driver-Based Planning

Driver-based planning is characterized by using formulas that rely on a thorough understanding of the relationship between the independent and dependent variables used to model outcomes. A simple example of driver-based modeling is forecasting sales by using a rate multiplied by units formula. A big strength of driver-based models is that they allow for quick and easy what-if analysis. All you need to do to see the results of different scenarios is to change a variable and the results flow through your model to let you see the outcome. These models provide great flexibility, but they require a deep understanding on the part of the modeler of how the variables affect each other. These models can also require more time up-front to develop than judgment-based or statistical models.

When creating a driver-based model it is important to produce one that is not overly detailed or complex, but one that is accurate and actionable. Avoid complexity by adding variables if they do not provide analytical benefits. Starting with the chart of accounts is not a good idea. The model should focus on key performance drivers. 

Identifying Key Drivers (80/20)

Every planning professional I’ve ever met is familiar with the Pareto Principle, also known as the 80/20 rule. It simply says that roughly 20% of inputs account for 80% of outputs. The interesting thing is, most people I’ve met routinely ignore this principle. 

A little analysis will tell you where the 20% are in your business. This will then be your focus when you’re designing your driver-based model. You may not need to use driver-based planning for every item you want to forecast. Let your 80/20 analysis steer your modeling. Your planning should integrate the operational elements of the business, not just financial data from the general ledger. Many of the drivers you will want to evaluate include non-financial, operational, variables. Here are some examples of financial and operational drivers:

Examples of Financial Drivers:

• Price
• Volume
• Margin
• COGS

Examples of operational drivers:

• Call Volume 
• Employee turnover
• Service Level: 
• % of orders fulfilled

One of the best ways to gain a deep understanding of the operational drivers is to get out of your office and get into the operations of your business. See how the business operates. Observe first-hand what makes the needle move in the business. When I had to develop the operating budget for the reservations department at Royal Caribbean Cruises, I spent some time observing reservation agents taking calls and booking cruises. This gave me a good understanding of what variables affected their call volume, average talk time, and a variety of other variables. This helped me immeasurably when I built a driver-based model to develop the reservations department’s budget.

Steps to Building a Driver-Based Model

Remember Pareto

The first thing I would do when building a driver-based model is the 80/20 analysis. First, figure out what you are going to model because it is not going to be the entire chart of accounts. 

Discovery

Once I know the output I’m looking for, it’s time to go into discovery mode. That’s where the operational experience I mentioned comes in. Go talk to the people in the departments involved in the things that drive the outcome you’re planning for. If you’re forecasting sales (in dollars), go talk to the vice president of sales and some managers in the sales department, maybe even some salespeople who are the ones racking up the sales. Gain an understanding of their sales cycle. What are the things that affect prices, discounts given, receivables terms, chargebacks/returns, sales volume, the timing of various promotions, etc.? These are all things that can affect your projection, so you better understand them. 

Put the Variables to Work

Now it’s time to build your model. Be organized and develop your formulas based on what you learned in the discovery process. Let what you learned to drive the level of detail in which you build your model. For example, if sales prices don’t vary, it’s sufficient to set up a price list and use that to drive all the formulas that involve sales price. If, on the other hand, your business runs lots of promotions or routinely gives discounts, you’ll want to build your formulas to incorporate these variables so you are not constantly reworking the model when things change. That’s the whole purpose for using this method, flexibility.

Using Technology to Enhance Driver-based Planning

There is a wide variety of technology tools that incorporate functionality that makes driver-based planning easier. Many of the newest planning software packages allow you to use formulas that are very similar to spreadsheet formulas, making the learning curve short and many planners still choose to stick with spreadsheets. If you go this route, you need to be aware of spreadsheets inherent limitations and proceed accordingly. Broken links, formula errors, data integrity and security issues abound in spreadsheets, so if you are doing serious planning, it is worth evaluating some of the other tools that are available.

Summary

My preference for driver-based planning stems from years of using them and understanding their strengths. It takes an upfront investment of time and energy to learn your business well enough to build a well-designed driver-based model, so it may not be the right choice for your purpose. If you go this route, though, it pays big dividends over and over again.