It’s June 1999. You are the CFO of a successful telecom-products supplier. Your vice president of strategy has just completed an exhaustive scenario-planning exercise. Of the several scenarios he presents, one says that in less than three years there will be an excess of telecom bandwidth that will drive your industry into a tailspin. You wonder how much money the scenario-planning exercise cost. Then you file it on your shelf and forget about it.
Such has been the fate of most scenario plans. As companies scramble for ways to predict an increasingly volatile future, many view scenario planning as a crystal ball–but then do nothing with the elaborate scenarios that result from most planning exercises. This is backwards. Scenario planning is useful not for predicting the future (which can’t be done) but for helping companies become more aware of possible outcomes. And just as awareness means nothing unless it is acted upon, even the best scenario planning is worthless unless companies use the scenarios to construct strategies that can succeed in those possible futures.
One critic of current scenario-planning exercises is Peter Schwartz, chairman of the Emeryville, California, consulting firm Global Business Network, and formerly head of scenario planning at Royal Dutch/Shell. During the 1970s, that company created one of the first scenario-planning protocols, now known as the Shell method. This protocol helped Shell predict and successfully prepare for the rise of OPEC pricing power. “Many more people are interested in scenario planning now, because the magnitude of the risks is rising,” says Schwartz. But, citing a recent study by The Corporate Strategy Board that reports that one-third of major American companies now engage in scenario planning, he warns that only one-third of them do it right. By “right,” he means testing the robustness of a company’s strategies under each scenario and updating the scenarios frequently as conditions shift. This is how such companies as American Century, UPS, and Cargill plan for problems and opportunities that their competitors never see coming.
Scenarios, says Schwartz, can be as narrowly or broadly focused as a company wants, and are best done in companies that have long product-cycle times, are capital intensive, or keep high levels of inventory. “They’re not good for fashion-focused or short-cycle companies, where there are infinite possible scenarios,” he says. “In those cases, the risks are not analyzable. What is the hot new toy going to be this year? No one can predict that. But if your company is looking at overall risks, that’s different.”
Scenario planning is an especially important tool for CFOs, who can use it as an early-warning system to reduce resources in anticipation of tough times or to staff up to take advantage of pending opportunities. “It allows you to understand potential risks, such as discontinuities that could dramatically affect earnings,” says Rick Eno, vice president in the global management consulting practice at Arthur D. Little in Cambridge, Massachusetts. The key, he says, is to identify “signposts” for each scenario: events or metrics that signal when a scenario is unfolding, such as a drop in the rate of adoption of a new technology or numerous debt defaults within a specific industry. When linked to a scenario, they serve as clues that allow companies to “move very quickly if you see things veering away from or toward your assumptions.”