In the mid-2000s, the consumer goods company Heinz faced stagnation in its market share and return on assets. To overcome this challenge, the company decided to initiate an improvement process in Europe based on S&OP. Heinz had a presence in more than 150 countries and sold 20,000 SKUs across 30 brands. As a first step, they transformed their top-down projection approach, built from financial targets by brand, into a bottom-up approach based on consensus consumption forecasts. Secondly, they centralized the S&OP process management in a specialized team within the Supply Chain Vice Presidency. Finally, they stopped guiding monthly decisions based on annual sales budget demands and focused discussions on forecast accuracy. In two years, they achieved their goal of a 95% fill rate and reduced working capital by 17%, improving competitiveness and profitability.

Companies with a more sophisticated implementation and use of S&OP can have 3 levels of application:

1. The operational process starts with monthly or quarterly commitments to volumes, costs, and margins, typically made in weekly meetings on unconstrained demand, capacity, and inventory constraints, alternative actions with impact modeled on volume and margin, and cross-functional agreements and commitments.
2. The tactical process takes a quarterly to yearly view, modeling alternatives and implications for profitability and return on capital employed (ROCE) to make decisions on changes over 12 months.
3. The longer-term strategic process, with scenarios and structural considerations for investments, systems, acquisitions, and strategic alliances — timelines in which “fixed costs” are no longer fixed.

On the other hand, several vertically integrated companies, such as some agribusinesses (e.g., Agrosuper) or forestry and pulp companies (Arauco), maintain financial rolling forecasts as the central axis of their management processes, also with increasing sophistication. In some cases, the budget becomes a 12-month monthly projection with a precise model of business variables (sales drivers, cost factors, activity-based costing “ABC,” etc.) that allows calculating the impact of tactical decisions on the company’s profitability month by month. The rolling forecast discussion involves all areas, although it is generally led by Finance or Management Control. Parallel to this, an investment selection process (sometimes known as the “CapEx cycle”) is carried out, elevating the management process to a more strategic 12-month level, sometimes with a similar level of product and cost detail.

Today, it seems that the S&OP and Financial Rolling Forecast processes, in their most developed form, are arriving at similar results, even though the former starts from operations to achieve profitability, and the latter from financial results and their factors to make operational decisions.

However, as each process expands and becomes more precise, executives face more dilemmas and confusion. For example, since the tactical S&OP process has similar timelines, decision-makers must know whether to prioritize the commitment to the budget or the tactical S&OP. Budget review meetings and tactical S&OP discussions will have similar information and discussions, especially when the company has, in addition to the annual budget, a re-forecasting process, sometimes called 3+9, LBE (“Last Best Estimate”) or Rolling Forecast.

The necessary abstraction to separate the two processes and the possibility of leveraging their respective advantages quickly disappears in the face of day-to-day management demands. For example, limiting the budget review discussion to explaining the past while limiting the tactical S&OP discussion to proposing future commitments ends up with substantial overlap: in the budget review, questions naturally arise about how we will return to budget for the rest of the year, and in the S&OP discussion, we will discuss what happened in the previous cycle, what the learnings are, and how to better align cross-functionally.

So, how can this apparent conflict between management processes be addressed?

In recent years, we have seen two types of practical responses among large companies in the region: Some companies have decided to maintain the traditional Strategic Plan and Annual Budget processes and focus the S&OP process on operations, explicitly separated from the budget. In this case, the budget is set for the year. On the other hand, the monthly or quarterly guide for short-term management decisions is the S&OP process. In other words, the management team reviews the monthly progress against the budget and explains cost or margin deviations, and in a separate instance, they discuss and validate sales, operations, and supply forecasts for the upcoming months. In this case, the year’s actual results — both volumes and profitability — will be close to the sum of the S&OP forecasts, not necessarily the annual budget.

Other companies have decided to separate by function, focusing the budgeting and rolling forecast process within Finance (organizations with a separate “FP&A” management), reviewing costs by area and cost line, while managing both tactical and strategic S&OP from Operations, Commercial, or Supply Chain. The discussion starts with volume projections, customer service, and risks to mitigate provided by the business areas and ends with feasible alternatives that maximize the resulting margin or EBITDA. In this case, the financial rolling forecast could be more accurate than the S&OP.

In both cases, the weight of each process’s performance in the incentives of those involved varies with the hierarchical level, with the budget weighing more at the top while operational performance should weigh more at the S&OP level.

The simultaneous application of both processes within a company can create confusion. As the developments of both processes (S&OP and Budgeting with Rolling Forecast), driven by experts, academia, and consultancies, continue to add sophistication and expand their scope, they are increasingly vying for executives’ attention at all levels.

But beyond their growing sophistication, we see that companies that achieve the following combination can unlock greater value opportunities:

1. The generation of a budget as a guide and definition of annual commitments and investments, both internally and with their board of directors.
2. The development of forecasting capability, which better incorporates market reality, internal and external volatilities, and fosters stakeholder commitment in monthly management.
3. A reflection that allows incorporating both previous points into new budget revisions and discovering/capturing new avenues of value that a rigid budget of the past did not allow.

The dilemma can be resolved when we complement the strategic uses and approaches of the business with new ways of approaching the market and generating value.

[1] Financial Planning & Analysis