Monday, July 20, 2009

Scenario Planning -- What's Old is New

I had lunch this week with a great friend and retired President, Ken Keller. He was President of Victory Life Insurance Company through the recession of the mid-1970s and the double-digit inflation of the early 1980s. Just before retiring, he was Executive VP of Insurance Operations for Liberty Life Insurance Company, the job that brought him to Greenville, SC, and the move that resulted in my good fortune of knowing him.

Ken is an extraordinarily disciplined planner, and he mentioned an article he'd recently seen on "Scenario Planning". I asked Ken to write a guest blog article on the subject, and here's what he had to say:

The headline, "Pendulum Is Swinging Back on ‘Scenario Planning’", from the July 6, 2009 issue of The Wall Street Journal in its “Managing” section was a timely reminder for planners and a call to action for all business executives. Pioneered by the U.S. military in the 1950’s, scenario planning gained a lot of advocates with proven results from some high-profile examples.

What is scenario planning? WSJ describes it as “preparing responses to imagined changes in conditions.” Actually that definition sounds more academic than the practical tool it really is. Operational planning normally takes a great deal of data gathering and careful analysis of sales by type, revenues, programs, projects and the budgets to support them.

Scenario planning is no substitute for that hard and essential work, but it can be an eye-opening supplement to that process. The operating plan details the actions the business is most likely to follow in the coming period, while scenario planning helps the business owner/manager to efficiently explore alternatives to better prepare for what might happen.

One memorable example is the scenario planning the New York Board of Trade did in the 1990’s that led them to build a second trading floor outside the World Trade Center, allowing the futures exchange to continue operating after the September 11 attacks. The WSJ article also cites that scenario planning helped Shell Oil weather the oil supply disruptions and price shocks of the 1970’s better than its competitors.

Scenario planning is particularly helpful when the future seems more uncertain than usual and when changes are likely to be severe and sudden. Such as now. You already have a plan for what you think is the most likely future for your company. The next step is to imagine alternative possible futures for your company that could happen. For example:

  • Revenues drop 25% in the next six months
  • Revenues drop by 50% in the next six months

Gradual declines let you adapt on the go but may also lull you into neglecting the preparation you would need to do to survive a major change. Scenario planning forces you to examine the essential steps you would need to take to survive and even prosper after dealing with the crisis.

For your business the issues might be different, just as for the World Trade Center the issue was creating duplicate facilities so they could operate in a disaster scenario.

What if the loss of a key customer through bankruptcy or critical issues of their own created a loss for you? What would result from the loss of key employees, the loss of a major funding source, or a disruption in deliveries from a major supplier? The idea is to identify the two or three most likely threats, given the current state of the economy, and then think through what you would do if one of them occurred.

In the late 1960’s I participated in a scenario planning session involving life insurance brought on by threats of changes in interest rates. We were given two scenarios to consider:

  • Interest rates go up by 3%
  • Interest rates go up by 6%

We weren’t to consider any rates higher than that because it was assumed the life insurance business simply couldn’t survive if rates went higher than that. However, within a couple of years, interest rates reached 15%.

The industry survived but what if the scenarios had been imagined more boldly to come closer to what actually happened? A couple of wasted years might have been salvaged, had the planners been challenged to prepare better answers.

Being overly optimistic is not a virtue in scenario planning because the unexpected does happen, and this tool could help give you extra days or months to think about what you would do if your business were threatened. The operating plan might fill a binder, but your scenario plan could be one page.

The important steps are:

  • Imagine potential threats
  • Think through the implications
  • Decide what steps you would take in response.

The effort will not be wasted. As one wise person said, “Plans are useless, but the planning process is indispensable.” Time spent thinking proactively about your business can only help you understand it better and prepare you for whatever might come.

If you have some good examples of how scenario planning has been useful to yourself or your compnay, please click Comments below and share those stories with others.

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Terry Weaver

Chief Executive Boards International

Chief Executive Boards International: Freedom for business owners & CEOs -- Less Work, More Money, More Freedom to enjoy it

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