As the business and macro-economic environment continue to change at rapid paces and increasingly getting complex, the pressure on the finance organization to support the core business by strategically addressing volatility, uncertainty and risk is also intensifying.
This fast changing environment is making it extremely difficult for organizations to forecast business performance with a greater degree of certainty. What we used to consider extraordinary is now the ordinary and the previously unthinkable is now reality. In this environment, organizations need to become more proactive, flexible, adaptable and not reactive. Traditional planning cycles such as the static annual budget are no longer ideal for this dynamic economy.
Past Performance is Not a Predictor of Future Performance
Despite significant evidence indicating this rapid change, many organizations are still relying on the annual budget for planning and evaluation purposes. What we tend to forget is the fact that the annual budget gives a false view of a stable future. By the time the annual budgeting process is over, the majority of the assumptions used to compile the budget are outdated. Additionally, most budgets solely use historical performance as a baseline for predicting future performance. Again, this ignores the fact that past performance cannot be used to mirror future performance.
Most budgets prepared by companies only have a financial focus, normally adding or deducting a percentage to previous year’s numbers. They lack specific consideration of the forces driving the business and value creation. The link between the strategy, planning, resource allocation and performance reporting processes is broken.
With the current volatility, uncertainty and complexity in today’s environment, companies need to adopt an agile mindset and new ways of planning. Working together with the other business functions, Finance can drive this process and lead its success. Taking advantage of the function’s analytical and risk management strengths, finance executives can use scenario planning to help decision makers identify and understand possible future events and their impact on strategy execution and business performance.
Scenario Planning
Instead of taking a static view of the future and basing key decisions on gut feel, scenario planning helps business leaders understand their business environment (any significant emerging threats and opportunities), identify the critical drivers of value and correlate their impact on performance, both operationally and strategically. It achieves this by enabling decision makers frame a number of questions on the strategic intent of the organization.
Regardless of your business’s industry sector, scenario planning is useful for getting different views of the future that reflect volatility, uncertainty, and complexity thereby helping you identify gaps in your organization’s ability to respond to threats and opportunities. Once you have identified the blind spots and gaps in your company’s response capabilities, you can then start building a dynamic risk management framework and gain knowledge of the risks you have direct control of or influence and those that you do not have.
When conducting a scenario planning exercise, organizations must:
- Define the purpose and scope of the exercise.
- Examine the internal and external environment for emerging trends and issues.
- Identify possible realistic future scenarios and evaluate their impact on the business.
- Formulate strategic and operational responses to each scenario.
- Monitor performance related triggers and regularly challenge assumptions
Scenario Planning is Not About Predicting the Future Accurately
Instead, it is about understanding the environments in which your business operates, discovering new insights, and increasing adaptability to changes in these environments. By constantly taking uncertainty into account when making decisions and also encouraging alternative thinking, you will be able test and evaluate the robustness of your company’s strategies against a range of possible futures. This in turn will assist you broaden your perspective and develop robust response plans.
Critical to note is that scenario planning is a continuous process rather than a once-off exercise and must be incorporated into processes for managing the business on an ongoing basis. The macro-economic environment is constantly changing and as such, an ongoing review of the drivers of performance and trigger points is necessary.
You need to constantly ask questions on the social, technological, economic, environmental, political and legal influencing factors and indicators.
Examples of questions that you might ask include:
- If you are an automaker, what is the impact of autonomous and electrical vehicles on our current business model? Are self-driving cars the future and how should we respond?
- If you are consumer company, how would the organization respond to growing emerging markets and the rise of the middle class workers?
- How would the organization respond to unexpected loss of a major contract that has sustained the company for a long time to a competitor?
- What are the short-term and long-term implications of a major product recall on your market position, reputation and the organization’s ability to meet strategic performance?
- What is the range of likely impacts on our brand, customers and supply chain, if one of our key suppliers files for bankruptcy?
- What competing products or disruptive forces will have the potential of threatening and forcing us out of business?
- What is the impact on our quarterly and annual performance targets of material short term changes in key external variables such as commodity prices, inflation rates, interest and exchange rates, GDP and consumer spending?
- How would the organization respond to unexpected external events such as a major natural disaster, political or regulatory actions, or occurrence of a pandemic?
- What are the likely advantages and disadvantages of moving our enterprise systems to a cloud-based platform versus retaining them in-house?
- What are the global business implications of UK leaving the European Union, and how would our organization react to such a move?
- What are the implications to the business of a data breach on key account information?
By systemically monitoring a series of performance related triggers, the organization will be able to anticipate major trends and changes in the industry or broader business environment, respond dynamically, gain competitive advantage and seize growth opportunities in both developed and emerging markets.
Scenario planning is more than a business threat analysis tool. It also helps you identify emerging opportunities, improve your business model and proactively address industrial and environmental uncertainties.