I thought of writing a note on this topic when multinational
corporations started to withdraw their deposits from eurozone banks, but the
pessimism that event engendered was short-lived. Now, as the monetary crisis
deepens in Europe, it’s perhaps time to ask what your company would do if parts
of its financial system implodes. You may think that your company will not be
affected because it doesn’t do business with the eurozone. Or you may believe that
it’s unlikely to happen and therefore not worth spending the time to consider
the implications. I think both assumptions are mistaken.
Several years ago, during the U.S. financial crisis, I was
leading a workshop on planning and budgeting. As an exercise I asked the
participants to consider what they might do in an intermediate-term scenario of
12 percent dollar interest rates and 10 percent inflation. Most immediately
reacted that “that will never happen.” Of course they were correct – it hasn’t
happened. However, that wasn’t the point. Planning is about considering what
might happen and understanding the specific, measurable consequences if a scenario
should come true.
Unfortunately, contingency planning gets short shrift in
most companies. People running companies, divisions or departments typically
have limited patience with formal planning processes and believe that spending
too much time on planning leads to “paralysis by analysis.” That can be true,
but contingency planning, especially in finance organizations, need not be
overly time-consuming if a company has the right planning tool and uses it
One approach to contingency planning is to have an
individual analyst prepare a spreadsheet that models the company’s business and
have the person use sets of assumptions about potential market conditions to
prepare a report on the outcomes of these assumptions. This method has the
advantage of being quick and consuming few resources. On the other hand, it is
hardly collaborative, even if the analyst solicits input from business heads.
Another approach is to replicate the budgeting process. Yet in many
organizations this would be far too time-consuming, especially if the data is collected
with desktop spreadsheets.
Corporations that already have a dedicated planning and budgeting
tool can use it to develop a streamlined contingency planning process that is
detailed enough to capture the key business drivers without requiring too long
to complete. This approach starts by identifying those key business drivers and
creating a model of the company that is driver-based. Even in a very large
corporation, a contingency planning methodology that manipulates assumptions
about the key drivers should enable executives and managers to explore collaboratively
a range of assumptions and determine the impacts these might have on different
parts of the organization and on the corporation’s profitability and cash flow.
The advantage of such a collaborative approach (rather than having a “black box”
analyst generate outcomes) is that it provides a useful structured dialogue
about what might happen and the best approach to take if it does. (“Structured”
in this sense means having hard numbers behind the descriptive language that
people might use.) The software tool would be useful in short one-on-one and
departmental meetings as well as in day-long, company-wide gatherings off-site.
At least for North American companies, one good reason for
doing more contingency planning is that given today’s economic conditions they
may have fewer options in reacting to major dislocations than they did three
years ago and less time to make decisions. Most midsize and larger companies
reacted to the last crisis by reducing headcount and limiting capital spending.
While capital spending has increased, these companies have been reluctant to
add people. Another crisis is likely to require spending cuts, but since they
already have less obvious “fat,” where should organizations cut? It’s unlikely
that across-the-board reductions would be the best approach, so executives need
to understand how best to adapt their cost structure to a given set of
conditions. It may be that the optimal approach is not to cut costs but to plan
to limit profitability or even to lose money under some circumstances. Getting
agreement on the latter two at the board level is best done before a crisis,
not during one; ensuring that sufficient finances are in place to support a
period of losses is only practical ahead of a crisis.
Keep in mind that contingency planning is not budgeting.
Budgeting is about getting to a fixed set of numbers used for control and
financial planning. Contingency planning is an open-ended discussion of what
might happen and the best approach to achieving a company’s objectives under those
circumstances. Corporations should make contingency planning a routine part of
management meetings. However, to make this practical they need to create a
streamlined process that incorporates driver-based business planning models and
adopt software that enables them to explore conditions and outcomes
interactively. Today, these sorts of meetings are limited to high-level
thinking, usually based on gut feelings. A more rigorous approach, one that
quantifies conditions and outcomes, is likely to produce better results.
Companies will be better prepared to deal with today’s volatile business
environment and make consistently better decisions faster.
Contingency planning requires companies to consider the
normal range of events as well as some that are more than one standard
deviation (in a general sense) from what’s expected. It requires incorporating
structured interactive planning into business management and having the right
tools, data and models available to make it interactive. What would happen to
your company if the unthinkable happens? It doesn’t have to be a world
financial crisis. It might be the loss of a major customer or the catastrophic
disruption of your supply chain. “Fortune favors the bold” is an ancient Latin
proverb, but Louis Pasteur is credited with the observation “Fortune favors the
prepared mind.” Both are necessary for success, in my opinion but the latter is
the concept most companies need to concentrate on.
Robert D. Kugel – SVP Research