The Revival of Scenario Planning: an Integral Part of Reliable Corporate Management
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Iulie 2010 |
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ERNST & YOUNG S.R.L. |
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Scenario planning can be an invaluable approach to improving corporate management in an unstable environment.
Executive summary
The global financial crisis has exposed a fundamental weakness in the corporate management approach of the majority of companies operating today. In this turbulent environment, the current set of control tools has become less relevant and increasingly inadequate. In particular, traditional corporate planning no longer fulfills its function given the current high levels of uncertainty, as it is very difficult to align planning assumptions with different potential future scenarios.
Scenario planning can be an invaluable approach to improving corporate management in an unstable environment. It can assist with the creation of flexible budgets and alternative courses of action for different scenarios. It can make a major contribution to safeguarding growth and to the survival of the company.
Scenario planning is not a new concept: largely due to the major contributions of the energy and petrochemicals giant, Shell, it entered the corporate management toolbox about 40 years ago. Despite this, it never really achieved a high adoption rate, although many companies now realize that it is an important element of corporate management in unstable conditions. Here, we explore why it is important to learn from past mistakes and to develop scenario planning as a integral part of corporate planning.
A new era of corporate management
"We steer by sight, not forecasts, and never before experienced turbulences like these." This statement was made by a CEO of a well-known company echoed by many others during the current financial crisis when asked about the future development of their business.
What would you think if you heard a statement like this from the pilot of your plane during a storm? You would at least expect the crew to have the appropriate equipment to select the best course of action, and the specialized training and experience to manage every possible situation.
Over the past few years, the demands on corporate management have increased significantly, due to the increasing insecurity that has come from a multitude of unexpected shifts in the macroeconomic environment. These can negatively affect the quality of business decisions, especially if they occur together.
Recently, deviations from budgets have risen from 5 to 10% up to 30 to 40% in some sectors. In many companies, there is a high level of uncertainty as to the permanence of these developments. Increasingly, volatile price and interest rates are a significant structural characteristic of today's economy.
The complexity and growing interdependence of the global markets add to the sense of uncertainty. The diversity of global markets and the interaction of economic factors on them further weaken a company's ability to make accurate forecasts.
While projections based on previous experience can make sense in a stable environment, this is no longer the case in times when long-term trends have an increasing tendency to break up unexpectedly. The greater the number of structural breaks in the relevant environment, the smaller the benefit of experience. In particular, an extrapolation of past performance can easily result in the failure to recognize significant future risks: the forecast then becomes a trap that requires a paradigm shift to remove it. The greater the uncertainty due to a variety of possible future scenarios, the stronger the need for a change of direction in thinking from the future to the present.
How does responsible corporate management deal with such a volatile environment? Does management have the appropriate tools “in the cockpit” to remain in control in severe and unpredictable weather?
Challenge the traditional tools of corporate management
The current crisis illustrates the limits of traditional control and monitoring tools. Such processes were not created with such a turbulent environment in mind. Consequently, they failed to adequately address the high levels of uncertainty the market is now seeing.
To successfully manage through the uncertainty created by this global financial crisis, traditional performance management tools need to be examined critically. This includes the following elements:
- Performance indicators and value drivers
- Planning, budgeting and forecasting
- Management reporting
Recently, the development of performance management has been marked by, among other things, value-based management approaches (shareholder value), flexibility, faster processes and more efficient management information systems. There has not been a particular focus on approaches to improve managing through uncertainty, but innovation in this area has now become critical.
Traditional performance management tools tend to be based on assumptions that become untenable in an unstable world. Some of the misleading premises that traditional instruments are based on are that:
Forward projections of the past can be reliably used as a basis for forecasts
- Decisions are made rationally
- There is always one solution that is superior to the others
Established planning methods, in particular, fail in times of high uncertainty; they take too long, are too detailed and too rigid. Above all, they are based on the assumption that the future can be projected from past experience.
As the type and size of business risks increase, it is more important than ever to improve control and monitoring tools to meet the high transparency requirements of the capital markets and impending changes to business models.
