Scenario Planning: Curse of the Black Swan

by Melba-Jean Bernad, 07 September 2009

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Black Swan Scenario planning

Everybody talks about risk management, but few think about managing uncertainty. They are not the same. You can formulate action plans for risks that happened in the past and experience suggests may happen again.

So if oil prices average above $100 a barrel over three months, implement Plan O. If customer payment default rates approach 5%, get ready to dust off Plan X.

But what if a Black Swan, as author Nassim Nicholas Taleb memorably calls a high-impact event that lies outside the realm of normal experience, hoves into view? Some analysts believe that this is exactly what happened in the global financial crisis.

Few companies were prepared for the unexpected, and so most got blindsided when the implosion of U.S. subprime mortgages set off a series of Black Swan-ish events that culminated in the Great Recession.

This is where scenario planning becomes an invaluable tool, because instead of just preparing for known risks, it imagines the unimaginable. U.S. car retailer Auto Nation did exactly that in 2006, Six Sigma consultant David Niles recently wrote in Forbes magazine.

At that time, experience suggested that U.S. consumers would go on replacing their cars every three years as auto companies offered cheap financing and taking out home equity loans made sense because of rising property values.

But Auto Nation imagined the unimaginable. What if Americans begin replacing their cars after five years? What if cheap financing dries up? “If they came to pass, they could (as they did) have a devastating effect on the industry,” says Niles.

Following its scenario planning, Auto Nation moved to reduce inventory levels and refocus on service operations. Fast forward three years later. The company has remained profitable despite the recession and its stock price has jumped four-fold since October.

Challenging Assumptions

First used by the U.S. military in the 1950s, scenario planning was transformed into a business strategy in 1970, led by Royal Dutch Shell and consulting firm SRI International. In the 1980s most large organisations began to take a more strategic approach to planning for the future.

For many companies, scenario planning is thus not something new, reports a Knowledge@Wharton article entitled “Eyes Wide Open: Embracing Uncertainty through Scenario Planning.” But the online business journal says that scenario planning is often not being practised in a consistent or meaningful way.

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