Since 2008, the global business community has been operating under extraordinary circumstances. After years of crises, extreme volatility and unforeseen 'Black Swan' events, the extraordinary has become the ordinary and the previously unthinkable has become reality.
Not surprisingly, scenario planning—a capability that helps manage uncertainty by providing alternative views of the future against which strategies, tactics and budgets can be tested—has become increasingly important.
As a broader range of companies adopt this capability, however, the mere ability to use scenario planning no longer provides a competitive advantage. Companies should consider moving to what Accenture calls Scenario-Based Enterprise Performance Management (EPM), in which scenarios are incorporated into processes for managing the business on an on-going basis.
Incorporating a scenario capability into an organization’s management processes requires seven steps:
Identify the key factors that can have a material impact on the organization. For example, consumer products companies may look at GDP growth and consumer spending; airlines at oil prices; global manufacturing companies at exchange rates and freight costs; and financial services companies at consumer credit quality, interest rates and asset prices.
Define relevant scenarios (typically three to four) that describe a range of future operating environments. For example, what if oil prices average US$75 a barrel, US$110 a barrel or US$140 a barrel?
Agree on a baseline scenario that will be used to develop/review strategy, set targets and develop operational plans and budgets
Develop strategic plans, targets, action plans and budgets using the baseline scenario
Develop alternative views of targets, plans and budgets under each scenario. Identify the major impacts and changes under each scenario. For example:
- What will be the positive/ negative impact on key financial metrics such as sales, margins and earnings under each scenario?
- How will investments/projects be re- prioritized under each scenario?
- What will be the impact on product mix, pricing and promotional spending under each scenario?
Identify relevant triggers and corresponding tolerance ranges for each scenario that should be monitored on an on-going basis in order to provide management with advance warning of material changes in the operating environment
Adjust tactics using the previously developed plans whenever established triggers/ tolerances are exceeded and generate a new forecast reflecting the change in scenario and the changes in tactics
These seven steps provide the basis for the entire Scenario-Based EPM capability, starting with strategic planning and supporting other key EPM elements ranging from target setting to planning to monitoring to action planning.
In today’s uncertain world the value of using scenarios in strategic planning remains high. Consider the implications of answers to the following questions on long-term strategy around market participation and positioning, research and development, and capital investment:
For consumer products companies: How fast will the emerging middle classes in Eastern Europe, South-East Asia and South America grow and will their consumption patterns mirror those of the middle class in North America and Western Europe?
For oil and automotive companies: Will the trend to more fuel- efficient power generation and transportation accelerate? Will there be a “tipping point” that triggers mass-market adoption?
For infrastructure and construction companies: Will nascent signs of political and economic stability in parts of sub-Saharan Africa translate into meaningful business opportunities?
Using scenarios to provide insight into the choices and trade-offs to be made in strategic planning can increase flexibility and provide access to a broader range of growth options.
Typically, organizations set targets on an annual basis to guide the annual planning and budgeting process. The targets are usually set based on past performance, strategic plan objectives and external market expectations (for public companies).
With a Scenario-Based EPM capability, a fourth input will be used: scenarios. The target setting process often involves a shift from setting absolute targets (e.g., sales of US$8 billion and earnings of US$1.2 billion) to the use of relative targets, whereby targets are set in relation to relevant external benchmarks.
For example, a company may be targeting to exceed industry growth by three percentage points. As the expected rate of industry growth would change depending on a scenario, so would the targets.
Planning, budgeting and allocation
Accenture research has found that more than four out of five companies that use scenarios extensively use them in their budgeting and resource allocation processes. Once targets have been set, each organization develops a set of tactics and resource allocation plans that seek to meet the targets. The budget is simply a financial representation of the tactics and resource allocation plans and serves to validate the adequacy of plans.
Moving to a Scenario-Based EPM approach adds one more step. Once the baseline plans are complete, each organization then identifies the changes to the tactical, resource allocation and financial plans that would take place under each scenario.
For example, a pharmaceutical company could show how the impact of a delay in regulatory approval of a new drug would impact marketing plans and sales plans. A retailer may adjust its merchandise assortments and promotional spending if the economy tips into recession.
There should be a resource allocation plan or ‘budget’ for each scenario that explains the impact on the organization’s ability to meet the targets that have been set. If, for any given scenario, there is a gap between target performance and expected performance based on the prepared budget, an action plan to close the gap should be prepared and agreed upon.
One major change of moving to Scenario-Based EPM is to recognize that the level of detail for resource allocation plans and budgets should not be too granular. In conditions of high volatility and uncertainty, the more detailed the budget, the more likely it is to be wrong. Effort should go not to more detail but to developing different views of different scenarios.
All projects and initiatives should be reviewed on a continuous basis to ensure the original business rationale still holds true. In situations in which there is a high level of uncertainty, the focus should be on channeling the understanding gained from the scenarios into decision making.
Where uncertainty is greatest, the objective should be to retain flexibility to react to changing conditions. This may mean entering into shorter term contracts so as not to make long term commitments when the near term is uncertain, using hedging strategies to mitigate risk, utilizing temporary labor instead of hiring full time staff, and other tactics that reduce risk or increase flexibility.
Evaluating the business case for investment
The case for investment entering new markets, building new plants, making acquisitions, launching new products, adopting new technology should be evaluated under a range of different scenarios to identify the circumstances under which specific projects might no longer be attractive.
For example, a consumer products company that is looking to enter new markets may look at the likely market demand for its products under a range of different scenarios based upon forecasts of GDP growth and consumer spending levels.
It is important to understand — before making an investment — the key assumptions upon which the investment is based. It is also essential to define clear ‘abandonment criteria’ that identify the scenarios under which an investment or project no longer makes sense.
Abandonment criteria should be tracked closely and should be monitored, along with the investments themselves, for continued validity. In the immediate aftermath of the near collapse of the financial markets in late 2008, a leading global airline rapidly determined that future traffic volumes would decline significantly.
This meant that the assumptions upon which the airline had based its capital investment plans for new aircraft were no longer valid. They quickly adjusted their plans by delaying delivery dates of committed orders and reducing the number of options they held to buy additional aircraft.
The transition to Scenario Based EPM and the use of abandonment criteria may also create new opportunities. The management team should identify and monitor a pipeline of projects that may become not only feasible but attractive if a new scenario becomes effective. Resources from a project that no longer makes sense can then be rapidly diverted to new opportunities.
One leading financial services company reviews its portfolio of projects on a monthly basis and does not hesitate to shut down projects that no longer make sense, reallocating resources to those that become more attractive. Such agility allows organizations to react to changing market conditions with speed and confidence.
Monitoring and performance measurement
According to Accenture research, 78% of companies that use scenario planning claim that they monitor leading indicators for key internal and external factors affecting their business. However, less than two-thirds of these companies have established tolerance thresholds for these indicators and connected them to scenarios to detect when the current baseline is no longer valid and when an alternative scenario has become material.
In Scenario-Based EPM, monitoring of indicators designated as scenario triggers takes place on an on-going basis. Monitoring frequency can vary depending on the volatility of different indicators and the business environment in general.
What should stay the same is a structured, consistent approach. At Eli Lilly, the global pharmaceutical firm, management tracks leading indicators on an on-going basis and review scenarios every six months, while a “watchers network” follows other developments.
As the charts below illustrate, the range of triggers and the business decisions they affect are broad. For example, in consumer-based industries, issues involving pricing, margins, product and service portfolios are common, while for commodity-based industries, focus on capacity and supply management is more prevalent.
Events That Could Trigger Business Changes
Click image to enlarge
Click image to enlarge
In Scenario-Based EPM, the key is to have pre-defined action plans ready for each scenario. The organization can then act immediately to implement such an action plan if it is clear that a particular scenario is unfolding.
Scenario changes can require changes in pricing, promotion, production, scheduling, inventory management and other operational components. Clearly, companies that have established scenario triggers and associated thresholds are in a much better position to maximize the benefits from early detection of scenario changes and execution of their pre-determined action plans.
One of the exemplars of this capability is the global shipping company UPS, which used scenario planning to understand the impact of an avian flu outbreak. A team of 20 employees explored scenarios that might unfold and how they would affect UPS and the general population. As a result of this initiative, UPS developed an in-depth contingency plan that could help respond to a severe pandemic.
To realize the benefits of Scenario-Based EPM, companies need to put the right process, people and technology in place.
Process. Before embarking on the journey towards Scenario-Based EPM, companies need to ensure that their current EPM processes are nimble and flexible. The key pre-requisites include:
- EPM processes built around key drivers of business value, which are incorporated into driver-based models and exception-based reporting
- a focus on the most volatile and material aspects of the business, minimizing attention paid to immaterial and non-controllable factors.
People. A change in mindsets is needed, requiring leadership commitment in three key areas:
- Program sponsorship by a member of the executive team
- Organizational discipline in implementing and then executing Scenario-Based EPM
- Developing a new mindset and capability that integrates scenarios into all steps of the EPM processes
Getting the right people working on building this capability is a crucial factor for success. The people selected should be aware of the external environment, thoroughly trained, and should understand the current operating model. They should bring cross-functional expertise together with a combination of analytic and creative minds, as well as excellent communication and facilitation skills. Such people should be able to tolerate a relatively high degree of ambiguity and uncertainty, and be empowered to make decisions based on such uncertainty.
Technology. According to Accenture research, only 40% of firms that use spreadsheets as their main planning tool perform ‘what if’ analyses, compared with about 85% of firms that use a more advanced technology platform and report a high degree of satisfaction with their planning tool.
The impact of technology is also pronounced in companies’ ability to build ad hoc scenarios in response to material “unthinkable” events. Only 35% of companies that use spreadsheets as their main planning tool are able to build such scenarios, as opposed to almost 70% of those with more advanced planning tools.
There has been a rapid evolution in technology capabilities over the last few years that is making scenario planning easier. Cloud computing offers the promise of providing access to advanced collaborative and analytic technologies at a price point that allows small and mid-sized organizations to effectively implement Scenario-Based EPM.
About the Authors
Robert Bergström leads Accenture’s Finance and Enterprise Performance practice in ASEAN and the Enterprise Performance Management Strategy offering group in Asia Pacific. Natalia Timofeeva leads the Planning, Budgeting, Forecasting offering group in North America. David Axson is an Executive Director – Finance and Enterprise Performance and is an accomplished author. This article is an excerpt from the Accenture research report Managing the Unthinkable: Scenario-Based Enterprise Performance Management, and was re-edited for clarity and conciseness.
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