scenario planning, Metapraxis consultancy

All managers, sooner or later, have to plan. Whether they are planning their day, or writing a budget, or putting together a project, they must look at their present resources, estimate their future needs, and assemble the proposed actions, deployments and expectations that will enable the planned future to happen. The documents, naturally, are stamped with certainty: you don't plan for failure. Yet you know that 'according to plan' is a hope, and one that's seldom completely realised - even if the world economy isn't suddenly turned upside down by terrorist disaster.

The managerial consequences of the Twin Towers horror are all over the business news. Bad variances are only to be expected against the background of worsening economic forecasts, with the OECD predicting negligible growth among its 30 member countries in 2001 and 2002. So Ford Motor is heading for its third consecutive quarterly loss; Apple's fourth quarter earnings fell by 61%; Cap Gemini Ernst & Young has abandoned its previous forecasts; even SAP, the German software giant, has been hit by the slowdown - the damage is universal.

TOLL OF TRAGEDIES
The tragedies in Manhattan and Washington are taking their toll, of course. But that's not the whole story. It's one that's been told before. The oil price shocks of 1973 delivered a smashing blow to the Western economies. But in hindsight the oil producers lowered the curtain on an economic drama - a hyper-inflationary boom - that was already drawing to its end. The shocks of September 11th and thereafter similarly dramatised and hastened a major event that was being played out well before the terrorists struck: the death of the long, lush American boom.

Businesses of all ranks, right round the world, have been caught out by an event that was as predictable as the bursting of the dot.com bubble (which, of course, was a material factor in the death of the wider boom). Now companies have to assess how great the economic damage will be on two counts: first, the impact of the recessions in key industries (notably electronics and telecommunications), which would have happened and were happening, anyway; second, the degree to which this impact has been intensified by the setback to consumer and corporate confidence after the terrorist onslaughts.

The key elements are predictable. No businessman can be blamed for failing to predict that suicidal fanatics would crash airliners into the World Trade Center and the Pentagon. But you can reasonably expect companies involved in the software and hardware of microprocessors to anticipate a pause, maybe a long one, in their phenomenal growth. Ford, too, had every reason to expect that its falling market share and rising production costs (a deadly enough combination) would have a grave impact on the corporation's profits. But was that stern possibility, really probability, factored into the car company's business planning?

If so, you would have expected management to react by tackling the underlying problems ('late products, lousy sales, low morale', according to Fortune) that caused the twin difficulties. The essential contribution of realistic business planning is to throw up areas that demand action. Most businesses, though, rely on single forecasts, embedded in budgets, which are not realistic at all. The practice flies in the face of logic. You can't know enough about the future, in most circumstances, to believe rationally that your most favoured guess is the most likely to come to pass.

Long ago, Shell Petroleum decided that the single forecast had severe defects, especially if the planning was handed down to managers by central staffs. First, executives were misled into thinking that the selected forecasts were the most likely to come true, instead of being those which best suited top management's requirements. Second, lesser managers were taken off the hook: if events belied the Shell forecasts, that was the planners' fault (for getting it wrong) rather than that of the managers, for managing badly.

SET OF OUTCOMES
Shell therefore became one of the first major corporations to adopt 'scenario planning', in which managers are presented with a set of possible outcomes. Management gets put back on the hook. Its task becomes that of putting in place policies that will cope with any of the eventualities. In its simplest form, 'Best World, Worst World', scenario planning has only two alternatives - the very worst fate that you think could befall the company, and the very best alternative, taking all rationally possible outcomes into account.

This is a most valuable check on plans: can they cope, for example, with a marked shortfall in the demand for your great new product? Just as important, can they cope with a massive, unexpected upsurge in orders? But Best World, Worst World doesn't provide enough data for planning as opposed to checking. You need more and more sophisticated scenarios, the most popular choice being three or four: more than that will become over-complicated.

Robert Bittlestone, managing director of the Metapraxis consultancy, mentions a range of three scenarios: (1) Possibly Over-Optimistic (or POO), (2) Perhaps All Likely (PAL), and (3) Possibly Over-Pessimistic (POP). How do these relate to the budget? If the budgeted numbers are similar to, or higher than, the Possibly Over-Optimistic scenario, trouble almost certainly lies in wait. In fact, that often happens - as every reader knows.

Sales are extrapolated from the previous year's figures, pushed as high as unit management dares to project; costs are also extrapolated from the past year, but pressed down as low as top management insists. If the actuals come out on forecast, everybody preens themselves; if they are above budget, self-congratulation reaches an even higher pitch. If, on the other hand, the budgeted profit fails to materialise, castigation and possible cutbacks are likely to follow - even though the whole process in most companies is essentially random.

DIFFERENT APPROACH
The scenario planner takes a radically different approach. Looking at the current world scene, for example, what do you believe that the future holds? A massive recession, second only to that of the Thirties? You might agree that this fits the POP label - Possibly Over-Pessimistic. A pause, maybe lasting beyond the end of 2002, followed by a return to somewhat below the growth rates of the Nineties? That sounds a more PALly (Perhaps All Likely) scenario.

On the other hand, business could turn out very much as usual. Just as the stock markets returned to their pre-disaster level, so trading conditions may quite rapidly come back to the pre-tragedy norm. There's an old stock market adage, 'Never sell on strike news'. Being translated, it means that single, short-term events, however dramatic, will almost never determine medium and long-term economic outcomes. If this applies to the awful events of September 11th, business sentiment and corporate experience will improve in 2002. This scenario is POO, Possibly Over-Optimistic, but must be taken into full account.

That's what scenario planning does for the manager. It forces you to think about the future and to consider what different courses of action should follow to meet different circumstances. One of the most common failures of thought is to ignore the possibility of events diverging from the single forecast. This failure is often compounded by refusal to change the plans when they are overtaken by events. If planning isn't flexible, it isn't planning. In its proper sense, planning provides a framework for reaction to all eventualities, and for action to make the best of whatever hand is dealt by fate.

The most robust strategies, by definition, are those which do not depend on favourable events to achieve favourable results. Fortune magazine, for example, has claimed that four men are entitled to smile from ear to ear despite the events and aftermath of September 11th. The quartet are Jim Parker, who has recently taken over from the legendary Herb Kelleher on the flight deck of Southwest Airlines; Lee Scott, the heir to the even more renowned Sam Walton at retailer Wal-Mart; Craig Barrett, who followed another legend, Andy Grove, at Intel; and Michael Dell, the living legend himself, at Dell Computer.

Author Geoffrey Colvin attributes their ability to grin to the continued profitability of Dell, Southwest and Intel when competitors are drowning in red ink; and to Wal-Mart's continuing financial and bargaining strength in a battered retail sector. In other words, the business models of the four (for which read their strategic plans) were more robust - sturdy enough to resist the impact of a miserable POP scenario. That's a statement of the obvious. But are there any Highest Common Factors which describe those plans, any lessons to inspire study and imitation?

LESS COST, HIGHER VALUE
All four are still enjoying the benefits of the business philosophies of strong and single-minded founders. A single phrase sums up their common approach: Less Cost, Higher Value. At Southwest, Kelleher didn't compete on the prestigious routes with the majors. He filled in the gaps in the route-maps with pioneering low-cost, no-frills operations. Innovative service and people policies helped the airline. But it's the simple, straightforward business economics that explain why in October - believe it or not - Southwest was valued in the stock market at a capitalisation which surpassed that of all other US airlines put together.

At Dell, the founder's heartfelt strategy was always to eliminate the middle-man (thus removing one or more layers of cost to the customer), while streamlining operations, both in the plants and the distribution system, to cut costs to the supplier. Michael Dell could afford to cut prices from the early days of the current PC recession, confident that even powerful rivals like Compaq and Hewlett-Packard would buckle under the strain. Sure enough, the pair are now trying to unite in a deeply troubled merger plan.

At Wal-Mart, the founding Walton planned on a quite similar basis. As a discount store operator, Sam offered cut prices, which were enabled by hard-nosed bulk buying and by computerised logistics whose speed and sophistication belie the folksy image of the chain.

On this simple foundation, Walton and his successors built a corporation of stupefying size; last year, the group had nearly half the revenues of the 16 largest general merchandisers, and a stunning two-thirds of their profits. With five times the sales of the also-ran, Sears, Wal-Mart before the Twin Towers nightmare had 18 times the market value.

The least happily placed of the four CEOs is Barrett at Intel. His predecessor's strategy of building the most and the most economic fabrication plants is paying off yet again. Like the other three, Intel can exploit the blessings of the low-cost, high-value supplier. But the basic platform is only as solid as the micro-processor industry, especially the Wintel sector that's dependent on Microsoft operating systems. Intel's costly efforts to reduce this key dependence on the Wintel market have produced poor pay-offs to date. Indeed, Microsoft's own fairly similar strategy has also taken its lumps - earnings fell 41% in the third quarter as it wrote off investments in cable and telecommunications.

THE SIMPLER, THE STRONGER
That teaches a second lesson from the Fortune Four. The simpler the model, the stronger the strategy. To put it the other way round, the more complex your planning, the less certain your ability to ride through the worst scenarios or to optimise your returns from the best. As Bittlestone notes, complexity threatens to be overwhelming, anyway: you need 20,000 charts to cover the reports of a company with 100 subsidiaries, each with 10 key product lines and 20 key performance indicators. Least is most against this background. But avoiding complexity itself requires clever planning.

Whichever way you turn, the answer is the same; planning, which used to be reserved to staff specialists, is now plainly a requirement for all line managers. Not only that; 'staff managers', too, need to be able to plan, to organise present activities to achieve the best future outcomes. Financial planning, for example, has to be flexible, agile and scenario-based. Finance specialists are still urgently required for vital tasks like checking, consolidation and analysis: but their most important work lies in devising and managing the business and financial 'models', the strategic constructs which drive the business forward.

Bad times like the present call, above all, for plans based on sound models and intelligent scenarios. But never forget, whether the right scenario is POO, PAL or POP, that plans are only as good as the actions that follow - and the speed with which the deeds are done.