Companies large and small knew there would be one of two outcomes in the U.K.’s European Union referendum last week. They knew it would be close, and in the days leading up to the vote, many polls indicated that the U.K. would remain in the European Union. But when the votes were counted, the decision had gone the other way: Leave.
The vote underscored an important lesson in corporate strategy: While companies can’t predict what the future holds, they can revisit and intensify their scenario planning around risk. Even if they don’t know exactly what events will create new risks and opportunities, creating scenarios and considering possible courses of action is better than a read-and-react or wait-and-hope strategy.
“The reality is we don’t have any better crystal ball than anybody else,” FedEx CEO Fred Smith said on a June 21 earnings call, days before Thursday’s referendum.
Organizations sometimes think of enterprise risk management as a project. “They do it once [a year] and they’re done,” said Mark Beasley, CPA, a professor of enterprise risk management and director of North Carolina State University’s Enterprise Risk Management (ERM) Initiative. “Big events force us to refresh our thinking about ERM needing to be a continual process.”
Organizations can sometimes get bogged down in the details of an event. Beasley recommends that companies think more about what would happen if, for example, they couldn’t sell their product for a day, a week, a month, or ever again. Instead of wondering what unknown event could lead to a sales interruption, have a plan in place for the repercussions.
In other words: Instead of thinking only about the cause, think about the consequences.
If companies are robust in risk planning, they should be somewhat prepared for major consequences, regardless of the cause, Beasley said. Essentially, the name of the event that causes a plan to be carried out, such as hedging on currency or using a new route or mode of transport to deliver products, is left blank. “Even though [companies] wouldn’t have had the scenario ‘Brexit,’ they would have a scenario about a currency drop or a market drop,” Beasley said.
Scenario planning became more important for companies after the financial crisis of 2008 and 2009. Since then, even in an era of growth in equity markets, volatility has become the norm in business. David Axson, a managing director of Accenture’s Strategy, Finance & Enterprise Performance practice, said the Brexit news is just another disruptive event in a world full of them. Response will vary by company and by region, but the importance to plan for such upheaval remains.
“It’s good stewardship to be aware of the possible implications under a range of different scenarios,” Axson said.
A tool for better planning
Scenario planning can be an orderly process, even though part of it involves embracing uncertainty. A CGMA report and tool, Scenario Planning: Providing Insight for Impact, offers six steps for organizations to take:
- Define scope, issues, and time horizon. Before beginning the exercise, ask what issues or decisions are being evaluated, what parameters are being used, and what the time frame is for making decisions and carrying out strategy.
- Define key drivers. What internal and external factors could potentially influence the scenario plan? Some examples include consumer spending patterns, the rate of technological innovation, or exchange rates.
- Collect and analyze data. Data should be predictive in nature and should focus on analysis of the relationships between key drivers. Drivers can be mapped based on materiality and predictability, sometimes referred to as impact and likelihood.
- Develop scenarios. Come up with two to four credible scenarios that are different enough to materially affect future decisions. One example: an interruption of trade to a particular country or continent.
- Apply scenarios. “Too often, organizations pour a lot of effort into developing rich scenarios but fail to apply them in the planning and decision-making process,” the report says.
- Maintain and update. Updating scenarios in response to new information forces managers to revisit original scenarios and develop an understanding of what worked and what didn’t. Also, updating scenarios helps identify opportunities and threats that have arisen since the original scenario was created.
—Neil Amato (namato@aicpa.org) is a JofA senior editor.
