A continuing challenge in business is trying to figure out what will happen in the future. While forecasting is challenging under any circumstances, it is particularly difficult in times of heightened degrees of uncertainty when markets may act in ways that differ significantly from what has been seen in the past. In this Part 2 of Paradigm Shifts we will look at the challenges of trying to see through the storm of Covid-19 and explore how businesses can cope with the lack of clarity.

Dialogue With the Future

There is an old expression that states that, whether we realize it or not, every person is a philosopher and the only question is what his or her philosophy is. A similar expression might be applied to forecasting. Regardless of whether we think of ourselves as forecasters or not, a good part of everyone’s life involves making predictions about the future.

It may be a forecast for a day, a week, a month or many years, but our lives are a constant process of trying to form a view of what will happen in the future and then planning courses of action based on those views. This dialogue with the future has an important impact on the paths in life that we follow and what our expectations are about where those paths will lead.

Our continuing dialogue with the future has an important impact on the paths in life we follow.

Forecasting is particularly important in business as business activity is built on expectations regarding what will happen in the future. These expectations include: whether the economy will grow or shrink; whether the demand for a particular product will increase; how supplies needed to make products will be obtained; how the labor market will evolve and how the competitive environment will change.

Further, many business activities require making concrete decisions in the present to prepare for future events including determining capital requirements, ordering product inputs, entering into contracts that hedge future risks and conducting research and development activities.

Types of Forecasting Methods

There are many types of forecasting methods that people and businesses use to make sense out of the future and make planning decisions.

Subjective Forecasting Models. The first general type of forecasting approach is based on subjective views and feelings about how the world will evolve. Subjective views can very in sophistication from random guessing, to views based on experience to opinions that are based on the positions of third parties, such as customers and experts.

Data-Driven Forecasting Models. The second type of forecasting approach is based on the collection and interpretation of data over a given time period. These models typically assume that the future will bear some relationship to this data, such as data averages, adjusted data averages or moving averages that take into consideration past deviations between forecasted amounts and actual results.

Relationship-Driven Forecasting Models. The third type of forecasting model is relationship-driven models that make forecasts based on the relationship between two or more variables. For example, if it is assumed that there is a fixed relationship between food demand and population size, if population increase is forecast these types of models suggest that the future demand for food can also be forecast.

This family of forecasting approaches includes econometric models, which are designed to make assumptions about the future based on many different types of variables and the relationship between them.

In practice, many types of business planning involve a combination of these approaches and it not uncommon to even see data-driven forecasting models include different types of subjective assumptions. Further, many forecasting models contain explicit or implicit feedback loops so that variances between what was forecasted and what occurred can be identified, the reasons for the variance can be studied and new insights about what is driving certain data patterns can be incorporated into new model iterations.

Forecasting in Paradigm Shifts

When trying to make reasonable assumptions about the future it is important to consider specific data not as standalone pieces of information but rather in light of larger economic, political and social trends. While sharply increasing sales may suggest that the commercial prospects for a product are bright, the increase in sales may be due to a specific event or market reaction that does not have a high probability of being repeated in the future.

To situate facts and events within a larger context, there are many market constructs that can be used but one relatively simple method is to divide market realities into three broad types of market states: (i) normal market situations; (ii) temporary market shifts; and (iii) long-term market shifts.

Normal Market Situations. It is of course extremely difficult to define a “normal” market situation because what can be thought of as a normal market state typically includes a significant degree of unexpected events and reactions to those events. However, a normal market situation can be thought of as market conditions that are broadly consistent with what has occurred in the recent past.

The concept of normalcy is highly relative and can vary significantly for different industries, industry segments and even times of the year. In some cases, a normal market state may involve a relatively constant set of conditions while in others those conditions may be highly volatile.

Temporary Market Shifts. A second type of market state is one defined by significant shifts that are temporary. These shifts can be caused by different factors, such as political events, economic shocks and social movements. Temporary market shifts are defined by two key factors: they represent a break from normal market conditions and they revert back to normal market conditions within a relatively short period of time, such as within a year.

Long-Term Market Shifts. Long-term market shifts are significant changes that do not revert to normal conditions in the short-term. These types of shifts can be due to massive changes in supply or demand, regulatory changes, technological changes or consumer demand preferences.

Many markets are comprised of different elements of these market conditions. Further, market forces tend to be highly adaptive and react to each other, meaning that in times of stability disruptive forces may emerge as a way to gain competitive advantage or alter industry conditions while in times of high volatility market actors may take steps, such as through the allocation of capital, which have a stabilizing market impact.

Current Situation

Based on what has been observed so far, it is likely that the impact of Covid-19 will represent a combination of short-term market shifts, an acceleration of some long-term market shifts that were already underway and new long-term market changes.

Covid-19 has had many impacts, including:

• Major restrictions on movement
• Significant fall in levels of disposable income, particularly for people in sectors of the economy that are heavily based on movement, such as the airline and hotel industries
• Significant impact on consumer and business perceptions; and
• Significant impact on economic activity.

While these are very important changes, given that these impacts are largely derivative of movement, it is reasonable to assume that as the uncertainty and impact of Covid-19 is increasingly controlled and increased movement again becomes possible economic conditions that are highly correlated with movement will also tend to revert to a more normal state.

It is also likely, however, that Covid 19 will accelerate some changes that were already under way and create new changes that will not revert to pre-Covid 19 realities:

• Use of Built Space. One likely shift that will occur post-Covid 19 is the use of built space. For many businesses, the realization that working from home saves overhead costs but does not lead to a significant loss of productivity will very likely cause a scaling down of the physical space that is used. A decrease in the need for space and the market need to use the space that currently exists will likely increasingly create a market for different types of shared space arrangements such as ghost kitchens.
• Density Distributions. Concerns about health risks related with high density areas and the ability to work remotely will likely lead to increasing housing options in areas that are farther from cities. This in turn will generate a need to rethink how services are provided and products are delivered.
• C2C Business Models. The combination of the need to seek out product substitutes, new potential buyer markets and affordability concerns has given rise, in at least some parts of the world, to more C2C business models where consumers have the ability to directly sell products to each other. Not simply stopgap phenomena, this has created sales channels for in some cases very good products that previously did not have convenient market outlets.
• New Digital Services. While virtual services are not new, Covid-19 has likely accelerated the market realization that many services, even those seemingly dependent on face to face contact, can be effectively provided in digital and virtual form. As consumers come to see these digital services as the market norm, it will produce offshoot services that strengthen the presence of digital platforms and market channels.
• Sales Models. The combination of the economic downturn and increased knowledge of consumer behavior through big data and data science will likely lead to sales models where many type of products can be purchased on individual economic terms. Further, economic and pricing models will likely become increasingly sensitive to shifts in market conditions and consumer payment ability.

Conclusion

Covid-19 has disrupted some economic trends that were in place, accelerated others and created new types of trends. To take advantage of new opportunities and face new risks, these economic realities should be considered by businesses when making predictions about the future.

For people who may be curious about the title of this article, Les Barricades Mysterieuses is a piece of classical music composed by Francois Couperain. Here it is if you would like to listen to it. https://www.youtube.com/watch?v=uZWf9neUf1I.