Alternate Realities

Responding to today's volatile environment, some companies are taking scenario planning to a new level.
Kate O'SullivanJuly 8, 2010

For the past five years, finance chief Mona Leung and her fellow senior executives at Alliant Credit Union have gathered annually to imagine how the company would survive various long-shot scenarios. “We don’t just ask, ‘Are we going to be in a recession?’” says Leung. “We try to find scenarios that represent the extremes. We ask, ‘What if we’re in a recession for 5 or 10 years? What if the U.S. fades from the world economic stage and the global economy is driven by India or China?’” The rigorous mental exercise “isn’t designed to predict what will happen, but to understand where our stress points are and to mitigate problems before they happen,” says Leung.

While Alliant may be ahead of the curve with its five-year track record, other companies are also developing more robust scenario-planning processes as they struggle to create relevant budgets and strategic plans.

“We have seen a sharp increase in interest in how to apply scenario planning,” says Steve Player, founder of consultancy The Player Group and co-author of the recent book Future Ready, a guide to forecasting. “This really began as companies reacted to the deep declines at the end of 2008 and most organizations found their traditional budgets for 2009 were essentially obsolete by the time they were printed.” Now, says Player, although finance executives can’t predict the future, “they can prepare for it by deploying robust scenario planning.”

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Making the management team aware of a wide range of possible scenarios helps it think about how to prepare and allows it to watch for signs that a certain situation may be beginning to unfold, says Player. Drawing up a playbook for the company’s response to what might seem an unlikely scenario “also assists in the situation where the totally unexpected happens,” he says, because the management team has thought through how it might ramp up or modify certain parts of the business in response to a low-probability, high-impact event.

Those finance chiefs who already conduct some scenario analysis are looking to take the process to the next level, says Janice DiPietro, national managing partner, consulting, at executive-services firm Tatum. “There is a recognition that the traditional ‘high-medium-low’ approach is probably not the way to go,” she says. “That kind of basic scenario planning is totally ineffective in this market.” Some companies, she says, are “beginning to use scenario planning across a broader range of subjects, like a new-product introduction or a joint venture or an acquisition.”

At Alliant, which serves United Airlines employees and has $7.2 billion in assets under management, the executive team typically begins the scenario-planning process by reading through four detailed scenarios provided by an outside advisory firm. Each of the hypothetical situations is more than 100 pages long and outlines not only the relevant economic numbers but also consumers’ behavior and preferences.

The company’s top executives then meet with the board and spend a full day testing Alliant’s strategy to determine how the business would hold up in each scenario. “When we look at that, we can see whether we need to adjust our strategy or our time line for certain things,” says Leung.

The process helps the management team and the board have big-picture conversations about risks the company might face and possible steps to address them, says Leung. In a scenario where the company’s earnings appear to be under pressure, for example, Alliant’s directors and officers discussed the possibility of pursuing higher-yield investments to generate improved earnings, but ultimately decided against it. “We realized we would rather weather the storm with the capital we have and let yields fall, that that would be a better route for us than taking higher risks for higher yields,” says Leung. “It might take us longer to recover in that scenario, but we’d prefer to have lower volatility.”

After the strategy meeting with the board, Leung’s finance team builds a balance sheet and income statement for each set of circumstances, carrying the financials out as far as 15 years into the future. The grueling effort requires hours of work, as the company’s financial analysts search for appropriate interest rates and unemployment rates to suit each scenario and drive their models. The resulting documents paper the walls of Leung’s office, a regular reminder of what might be.

The entire process — from the first reading of the scenario outlines to the final financial modeling stage — takes a couple of months to complete, at which point Leung and her team turn to budgeting. But the undertaking is worth the time and energy, she says. “Scenario planning allows you to consider risk holistically rather than reacting to one incident,” says Leung. “It forces you to take a step back and really focus on your strategy.”