Future Tense

The financial crisis obliterated corporate forecasts. Now, CFOs struggle to assess what lies ahead.

Age of Certainty

If the downturn in the economy does anything for corporate forecasting, it might be to sway organizations to become habitually conservative in their financial planning.

Apache Corp., a $10 billion energy exploration and production outfit, “constantly reassesses what the future looks like” based on the latest oil and natural-gas pricing and other macro inputs, says Roger Plank, the company’s finance chief. But the modus operandi is to “plan for the worst and hope for the better.” In its three-year projections, Apache uses a lower-price forecast for oil and gas than market pricing indicates, to prevent having capital spending outrun cash flow if oil prices underperform the futures market. “When I started with Apache, every year there was an escalating assumption, but prices didn’t cooperate,” Plank says. “The rate of return didn’t turn out to be real.” Forecasting more conservatively has allowed Apache to build up a $1 billion cash position.

The downside risk is slow growth, but Plank thinks it’s a risk worth taking. “Anyone can assume higher prices and borrow against that, but with today’s prices that doesn’t make sense,” he says. “It’s worth missing out on a little of the upside in order to be flexible and have money when others don’t.”

Vincent Ryan is a senior editor at CFO.

Mapping the Future

Can intuition succeed where facts fail?

Multiple standard deviations from the mean are by definition rare, so it’s not surprising that a world banking crisis caught many companies unawares, even if it seems wholly predictable in retrospect. Nor is it unexpected that CFOs are now scouring the horizon for more such “black swans.” Supplementing straight-line extrapolations with scenario planning — the kind of forecasting that emerged from Royal Dutch Shell’s planning department in the 1970s — can help executive teams challenge deeply held beliefs and assumptions, and cut down on blind spots about the future.

Scenario planning creates a set of stories, or narratives, that aid executives in thinking about “multiple, plausible, relevant, challenging futures and how a company might respond if they unfold,” says Nick Turner of Global Business Network, a consultancy. “It’s thinking about the horizon beyond the horizon.” Scenario planning is not an attempt to predict the future or write contingency plans for every possible outlier; it’s more about highlighting the limits of executives’ perceptions around a core business question — like whether a firm should expand into China.

“Scenarios are really about helping to inform intuition,” Turner says, instead of “just looking at the data and the facts.” They help companies plan strategic options in light of what future events might imply for their industry, clients, and products. “Scenario planning is like fast-forwarding five years and writing the history of the period — how events unfolded and what the actors were doing,” says Turner.

Recently, Global Business Network produced a set of scenarios for the political and economic fallout of the global financial crisis. The consultancy created a matrix defined by two key uncertainties: the depth and length of a global recession and the nature of political leadership during the crisis. The four resulting possibilities range from a scenario in which house prices recover and a mild recession results in global financial markets remaining decentralized, lightly regulated, and highly liquid (a scenario now increasingly less plausible, unfortunately) to a story line called “the global unraveling,” in which a long, deep recession occurs and “outrage about the socialization of economic losses provokes populist, protectionist, and anti-immigration sentiments” among nations.

If scenario planning sounds resource-intensive, it can be. A company may have 20 to 30 people constructing scenarios simultaneously. And a broad, diverse group of corporate leaders must be engaged: these include decision makers, knowledge-holders, and “the creative and the curious,” Turner says. “If you just listen to yourself and the same people you always talk to, you’ll miss the big idea — often people won’t want to consider certain possibilities, because they don’t fit their ‘mental maps.’”

Senior sponsorship is essential, and even the consultants caution against leaning too heavily on consultants. Much of the value in scenario planning is the “journey, the conversations with colleagues about what the future may hold,” Turner stresses. As one futurist has said, the forecaster’s task is to map uncertainty. In this business climate, scenario planning may be the closest thing to a GPS you’re likely to find. — V.R.

How far out CFOs can reliably forecast revenues

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