Contingency Planning, Now More than Ever
August 03, 2010

It turns out that some consumer goods manufacturers and retailers are having a hard time finding space on container ships and even finding containers to ship in. This has driven up the cost of shipping these items and at times resulted in deliveries arriving too late for scheduled promotions or seasonal demand peaks. This, during a time of constrained consumer spending in North America and Europe and an extended period where the Baltic Dry Index (a measure of shipping rates for bulk commodities such as ore and grain) has been dropping at a record-breaking rapid clip. This sort of unexpected and counterintuitive event has been having a negative impact on the affected companies. Could they have anticipated this possibility? Should they have? I think the answer is: Yes.

The events of the past three or so years should have taught everyone the value of contingency planning. Naïve extrapolation works well enough in steady state environments, but the turmoil in most markets just before, during and now after the end of the recession has routinely made companies’ plans obsolete very quickly. Companies need to be able to think the unthinkable and understand the impact of potential anomalies on their operations and ultimately their bottom line.

Very likely there is some degree of contingency planning going on everywhere in a company. The problem is that it’s often done in people’s heads and perhaps expressed in passing conversations or briefly mentioned in a meeting or two. To be truly useful, contingency planning must be done collaboratively across business silos and in a structured fashion. Structured in the sense of attaching numbers to these scenarios and running them through a business model to see the impact on inventories, sales quotas, schedules, revenue, cash flow, market share and so on.

Today, in most businesses, these sorts of exercises are usually confined to a business silo or two. Our research shows that the main company-wide collaborative planning and review activities are about the budget. Few companies have adopted what we call Integrated Business Planning. Yet budgeting and planning are two different sorts of forward looking exercises. The purpose of budgeting is fixing a forecast to achieve fiscal control. The purpose of planning to find ways to achieve business goals through an open-ended exploration of possibilities. When the purpose of the exercise is mainly to make options as finite as one can (as it is in budgeting), contingency planning winds up limited to an optimistic, conservative and base case. It does not anticipate explicit bluebirds or black swans and how to deal with them.

Companies usually don’t go out of business because they fail to do contingency planning well. However, they routinely fall short of their potential because in scrambling to deal with a crisis situation they don’t react fast enough or make the best decisions or respond in a coordinated fashion. All of this costs time and money. Rather than being able to use unexpected events for competitive leverage, they at best will match their rivals.

Beyond confusing budgeting and planning, companies fail to do the right kind of contingency planning either because they lack the proper information technology – a dedicated planning application – or they fail to use their dedicated planning application to support an explicit contingency planning process that is designed to anticipate opportunities and threats. Having a contingency planning process that examines the potential impact of foreseeable but unlikely events does not have to replace a company’s budgeting efforts. It will complement budgeting and improve the individual planning efforts that go on in most parts of the business independent of the budget. The economic turmoil of the past three years is unlikely to go away soon. Managing successfully over the next several years will mean doing a better job of anticipating the unlikely and unusual. The tools that facilitate more rigorous, complete and integrated analyses are readily available and may even exist in your company. Now, more than ever, companies need to make it a standard piece of the operational and financial planning.

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Regards,

Robert Kugel CFA - SVP of Research


 

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