Financial Forecasting at Atlantic Richfield Company (1992)

Atlantic Richfield Company (ARCO), one of the leading integrative oil companies in the United States, has become a giant in profit making in the oil industry since its major restructuring in 1985. With average returns on equity of 24% over the last six years, ARCO's stockholders have enjoyed on the average a 73% rate of return on investment. Executives at ARCO attribute the firm's high level of success to its visionary planning. BUSINESS ACTIVITIES Arco conducts oil and gas exploration, production, transportation, and refining and marketing operations most extensively in the United States. Refining and marketing operations are centralized on the West Coast, with Arizona, California, Nevada, Oregon and Washington being the primary states for premium outlet locations and AM/PM convenience stores. International oil and gas operations exist predominately in the United Kingdom and Indonesia. The Company also operates the largest coal mine in the United States, Thunder Basin Coal Co., and holds interests in three other coal operations in Australia as well as in two chemicals companies, Arco Chemical Co. (83%) and Lyondell Petrochemical Co. (49.9%). THE PLANNING FRAMEWORK At the corporate level, financial planning for these various segments of the business uses an economic model based upon the DRI data base. A modification of the DRI database, specified to fit supply and demand models for the oil and gas markets, generates multiple scenarios with different sets of assumptions. These analyses form the basis for a common set of oil and gas price assumptions, and for a common economic scenario that the executives use to develop the financial plan. TOP DOWN AND BOTTOM UP PLANNING The financial forecasting process is essentially a blend of top-down and bottom-up planning. The Corporate Planning Group releases the assumptions to operating company planners, who develop the various operating company strategies, using the assumptions as a framework. Operating company planners make decisions about what projects they intend to pursue, and develop financial plans for their operating companies. The financial plans then return to Corporate Planning for consolidation. Al Baker, Manager of Integrated Planning, coordinates the consolidation of forecasts at the corporate level. Mr. Baker's group is responsible for compiling the numbers and formulating the total plan. After top-management approves the plan, the board of directors reviews it and makes recommendations. SYSTEM DESIGN FCS, a specialized program adapted from the computer language STRATEGM, facilitates the consolidation process. Based upon the Corporate Planning Group's specifications of a financial model, the program performs the consolidations and assists in financing and investing decisions. By setting boundaries on specific input variables, the program can compute the effects on dependent variables to determine pro-forma outcomes under different scenarios. It contains a financing loop that allows management to run scenarios using different cash positions, which is useful in analyzing implications for capital expenditures and net income. ARCO successfully converted the system from a mainframe to IBM PC 386 hardware several years ago, after PC capacity had become powerful enough to handle the system's requirements. PLANNING STUDIES To gather information for developing assumptions, ARCO conducts special planning studies each year, called Strategic Business Unit Reviews. The topics of these studies are determined by identifying and setting priorities for specific areas where financial forecasting can be improved upon by acquiring a better understanding of the markets. The most recent example of a study of this type occurred in 1991, when natural gas prices became a topic of concern. To improve upon the accuracy of price forecasting, the study focused upon natural gas supply and demand. Other recent planning studies have focused on West Coast gasoline marketing, Commonwealth Republic business opportunities, and liquified natural gas. …