As economic uncertainty becomes the norm, companies are looking for more imaginative ways to manage risk. Perhaps it's time scenario planning made a comeback?
How many in the financial industry, even among those who saw the downturn forming, considered in detail its impact on employment, the economy, the NHS, financial services regulation?
Yet risk management is an essential element of running a business. Already, this year has been so fraught with landscape-changing socio-political events and natural disasters that Wall Street wags talk of ‘Black Swan fatigue’.
Smaller UK businesses that may have been insulated from fluctuations in the yen or a freeze in world cocoa supply are likely to find themselves having to factor such issues into their planning, along with myriad questions surrounding the UK’s own economic prospects. If the financial crisis failed to make risk management a priority, then surely the continued uncertainty plaguing domestic and global markets will.
For many boards, ‘thinking the unthinkable’ is now a daily necessity, and one that may call for a more sophisticated style of risk management. Scenario planning is one option, a technique made famous at Royal Dutch Shell in the 1960s and 1970s.
In scenario planning, executives create scenarios around specific issues facing the business. Each is effectively a story, a detailed picture of one possible future and how the business will respond to it. “We would definitely advocate that businesses consider several potential future scenarios,” says Mark Taylor, Business Process Improvement Partner at Baker Tilly. “While singletrack budgeting has its uses, the danger of having just one forecast for the future is that there’s always a ‘worse case’ around the corner.”
Scenario planning allows you to imagine some of those cases in the context of your company. It is also inherently forward-looking. While traditional financial models tend to use historic data to predict the future, scenarios operate in the realm of ‘what if’, combining predetermined elements – or ‘knowns’ – with uncertainties, which can often reveal hitherto unforeseen threats – and opportunities.
Taking a step back
Often considered the preserve of the biggest businesses, Mark Harwood, Head of Risk and Corporate Governance at Baker Tilly, sees scenarios as a valuable tool for owner-managed concerns. “The natural inclination for small business leaders is to get their heads down. But it’s great to step back and think about the bigger issues the business is facing.”
He recommends taking a day off site and even bringing in a facilitator to provide objective guidance: “I used to be cynical about facilitated sessions, until one meeting with three manufacturing bosses revealed that each had a different idea of where they wanted the business to go. Looking at risks and what you want to achieve often identifies issues that are ‘bubbling under’.”
Finding the best set of indicators is vital to ensure scenarios are relevant. While they are imagined, they must be rooted in accurate management information, such as budgeting and demand forecasting, current cash flow and workforce output, or qualitative data based on conversations with the sales force.
Diversity of input is key: managers should gather views from a range of stakeholders. “It requires a joined-up approach from the top team, not unilateral decision-making,” says Taylor. “Financial departments need to speak to key sales and operations colleagues – effective scenario planning is about joining up all the elements to create a more complete picture.”
Harwood also suggests looking outside the business, getting together with peers or with noncompeting companies to gain even more varied opinions about your industry’s future.
How it works
Once a company has gathered up perspectives and potential issues, it’s then possible to draw up stories about them – exploring the implications of, say, a change in technology. Since having an endless number of scenarios is pointless, the best ones need to be selected based on their importance and the likelihood they could happen.
Harwood suggests including scenario ‘check-ins’ as a regular part of management or board meetings, to assess where you are against the company’s strategy and risk plans. “It’s not enough to check your risks annually. Things in the real world move more frequently,” he says.
Scenarios must also be rooted in relevant business issues. At board level, for example, what if the CEO departs with short notice? How would investors respond? Is there a way of dispersing key knowledge so one person’s loss is less of a disaster? Does the business need to create an advisery board? And so on.
Regulatory and industry changes can be tougher for scenario planning, but also more valuable, and highlight the value of scenarios in combating complacency. For example, in failing to respond to the smartphone revolution led by the iPhone, Nokia went from a market-leader to one whose future is still uncertain.
It’s not just for doomsday scenarios. It can be used to consider how businesses might respond to opportunities, too. “What if one of your key competitors goes out of business – would you be ready to take advantage?” asks Taylor.
Don’t confuse strategies with scenarios. “Imagine you’re steering a sailboat. If the wind changes, you need to change tack. But you’re still heading in the same direction,” says Harwood.
The best businesses already use scenario thinking, to stimulate innovation and knowledge sharing throughout the organisation, but there must be a consideration of available resources. “There’s no perfect approach – after all, you can’t predict everything,” concludes Taylor. “There has to be a balance between time invested and what is practical for the business.”
