Eleven Contingency-Planning Tips

CFOs should note that plans must be tied to budget and performance goals, and that fast action means better results.
Bill FryOctober 30, 2013

When people hear “contingency planning” they most often think about things like hurricanes, floods and fires. But contingency planning focused on business performance is vitally important. Every business needs a detailed strategy that outlines the steps it will take if it fails to meet — or, conversely, exceeds — its budget and performance plan. Indeed, in contingency planning, the upside is as important as the downside.

What? A contingency plan is needed in case you exceed plan? Yes.

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Bill Fry, American Securities

Bill Fry, American Securities

Every company develops a capital expenditure plan and a list of desired projects. Most budgets limit the number of capital projects so as to reduce risk and manage cash. But a company might, for example, develop and maintain a much longer list of potential projects (all with paybacks of less than four years) and review those with the board of directors, even if not all of the projects are approved in the current-year budget. When the company finds itself well ahead of budget, it then proposes to the board additional projects already on the list (that have been pre-vetted). Such planning allowed the company to move much faster.

Contingency plans in general allow companies to mount quick, effective responses to changing conditions. Without that capability, losses can accelerate or companies can lose out on valuable opportunities. And you can never get back lost time.

Contingency planning should start with the annual budgeting process. That establishes a baseline for below-expected or great performance and defines key assumptions about the important markets a nd competitive impact. It also provides a structure to identify, quantify and prioritize risks and opportunities, set productivity goals and allocate resources.

While each contingency plan will be tailored to the needs of an individual company, it should include the following key components and potential actions.

Always have clear trigger(s) for action. Triggers could be sales or EBITDA misses (either overperformance or underperformance), or budget assumptions that prove to be incorrect. By keeping a close eye on factors linked to the triggers, companies can get an accurate, fast read on changing conditions. For example, is a sales decline a temporary blip, or the beginning of a sustained downward slide? It’s not always desirable to wait for the trigger if there’s a strong trend. “Rationalizing away” the trigger as only temporary can be costly in terms of time. The best companies look at multiple indicators of performance, not just sales compared to last year or budget, but also to trends like overall market growth, market share and competitive share.

Define specific actions to meet certain conditions. The best contingency plans identify multiple scenarios that cover specific actions the company will take under certain conditions. These scenarios include various levels of action, depending on the size of the problem. Not every plan miss will require the same level of response; having options offers flexibility and the ability to target the response more precisely.

Each action should have a defined owner. Vigilance and accountability are key factors in the success of a contingency plan. One person should “own” each action. Moreover, each action should have a quantifiable outcome. The “owner” is responsible for achieving the action’s objective.

Time is the enemy. A good plan executed quickly is often better than a perfect plan that takes too long to develop and implement. With a plan in place, a company can avoid the lengthy process of analyzing threats or opportunities, devising possible solutions, seeking consensus and approval, and executing.

Adjust bonus accruals. Bonus accruals are often the easiest and least painful source of contingency dollars. If the situation improves, the company can always increase bonus accruals. Bonus plans should always adjust automatically to underperformance where tied to EBITDA generally and minimum EBITDA for any bonuses to be paid. If a company underperforms, it may be preferable for these dollars to go back into the company’s income. A lack of (or decrease in) bonuses can get people’s attention and indicate that the issues facing the company are real.

Assess revenue and resource allocation. Selling more to existing customers is always faster and has a greater impact than new products, customers or geographies. Moving resources to programs, products and ideas that are working and away from those that are not will have a quick and meaningful effect. Stopping a negative can be the most powerful action. Every business has a resource-allocation plan, either stated or implied: It will invest more in certain areas to receive a certain benefit. Often, though, companies do not reassess such plans to determine if they are actually generating the proposed benefit. These investments should be considered quickly in a contingency environment: do we need more resources? Do we need less?

Don’t overlook price. Adjusting prices can be a source of quick profit that can mitigate the impact of underperforming investments of time and money. Although sales may be lower than expected, there also may be hidden value that can be captured through pricing. Often companies look at price and margin on a gross level and fail to focus on the micro level. In every product portfolio, some products add more or less value to customers. Some are in shorter supply. Is the company receiving the full value for the product or service? Should certain prices be higher to reflect the value to customers? For example, for many businesses a 1 percent increase in price results in a 10 percent increase in profit. Price is a big lever.

Fixed cost reductions can have a big effect. Fixed cost reductions generally have more influence than variable cost actions, which by definition will be reduced in value as volume declines. Savings on the procurement of materials, services and logistics is one variable cost that can bring about an immediate result. Companies can be tricked into thinking costs are declining when in fact they are variable and declining with sales or volume. Good contingency plans consider fixed costs and adjust those items down to reflect the new, lower volume. When volumes recover, the company benefits significantly to the upside. That is what happened for many companies in the aftermath of the global financial crisis. Companies reduced fixed costs from 2007 to 2009 and earned a disproportional benefit from increasing volume in 2010 and beyond.

Consider the balance sheet. The balance sheet, specifically working capital, is often overlooked in contingency planning. Paying down more debt than planned, even if EBITDA is below budget expectations, can still be a win.

Communication is critical. Broad communication is essential to fast implementation. Employees need to know what’s happening and why and how they can help. If everyone is fully informed, executing the contingency plan will go much more smoothly. Also, employees often contribute valuable ideas and insights.

Share the trade-off discussion. Transparency is a must. Clearly discuss the trade-offs with partners and the board. The right answer might be to ride it out. The partnership will be better if everyone is aware of the tradeoffs and makes them together.

Having a sound contingency plan in place and minding some or all of the actions outlined above will go a long way toward successfully managing off-plan performance. In good times or bad, a contingency plan can provide a path to help weather downturns, manage risks and seize opportunities.

Bill Fry is a managing director at American Securities and leads the firm’s Resources Group, which helps portfolio companies create value by providing them with talent in operations, strategy, information technology, human resources and pricing.