Online analysis: In a world of risk, is scenario planning the answer?

Who could have predicted the scale of economic upheaval of the last two years? It's not a rhetorical question - because most likely it's very few. But those that were able to prepare, to some degree, for such an eventuality have the opportunity to not just survive, but to be in a stronger position when the dust settles.

A recent survey by the Economist Intelligence Unit found that the economic turbulence gave many CFOs cause to adopt short-term decision-making strategies while also taking a lot longer to act on strategic decisions. Procurement is hardly immune from that.

Scenario planning wouldn't claim to say exactly when a financial crisis is about to happen, but it would give a clear roadmap of what the impact could be, what the early signs are and how different responses might play out.

In the example of behaviour during a downturn, a short-term focus and delay in decision-making can have less of an impact if scenario planning has already put stress-tested solutions in place beforehand and helped clarify the extent of a situation as early as possible.

Scenario planning is generally done through workshops where small teams are asked to plot potential future scenarios using, for example, a two-by-two model or by coming up with radically different futures and investigating how these scenarios can unfold over a certain amount of time. These can be on a range of issues, from those of global scale down to very targeted matters affecting different parts of the business.

For procurement, it offers the opportunity to test how supply chains would behave under various conditions, how internal pressures, such as those from finance, might affect the role, and to learn which strategies would be prudent in a given set of hitherto unforeseen circumstances.

The practice has been around for a while and has several different approaches and formats. And, while it causes plenty of polarised opinion, now more than ever there are strong incentives to turn 'unknown unknowns' into 'known unknowns'. Improving long-term risk management is just one of these.

If anyone needed reminding of how pressing an issue risk management is, the Audit Committee Institute of KPMG LLP provided further evidence in recent research. "It's [...] clear that risk oversight is at the top of the agenda not only for companies and boards, but for investors, legislators, regulators and others," said Henry R. Keizer, KPMG's global head of audit.

Being able to understand and act on vast amounts of information is a crucial part of the procurement role today and whether that information is the forecast for next month's commodities or an assessment of how a political, legal or economic event in two year's time could affect a particular supply chain, there's a lot to gain from knowing where the risk could lie and implementing the right strategy.

Jason Busch, executive editor of Spend Matters and managing director of advisory firm Azul Partners is adamant that this is a key tool. "In today's rapidly changing economy, we must supplement old approaches with new if we're to succeed in analysing and preparing for the future", he says.

Essentially, procurement functions are as vulnerable to the unexpected as any other and more than many. Risk management, itself a practice that remains unpolished among global corporations, is frequently only able to react after problems emerge rather than recognising them early and adjusting.

As yet, few would disagree with the suggestion that companies with a more effective risk analysis strategy are at an advantage. Scenario planning takes this a step further and looks at 'what might happen in the future' rather than forecasting what should happen given, for example, a 10-15% variability.

"No traditional planning technique would assume 50% volatility in the price of key commodity inputs over a 12-month period," says Busch. "And certainly no finance and accounting-based financial model would think to include a similar 50% demand variability for our own new customer orders. But these are precisely the types of examples that did occur in many industries following the credit crisis."

The benefits for business are far more than simply being able to know that an event, for example an economic collapse or a war, could dent commercial activity.

On one level, the aforementioned roadmap itself provides functions with a series of, as Busch puts it, signposts that a company can recognise and adjust to, based on the scenarios it has already looked at.

But beyond this, the ability for this activity to present a scalable set of causes and look at a tangible set of outcomes ties in other business functions. This helps procurement understand further its place within the company, within the market and within the economy.

"One of the key tenets is that it allows us to see how scenarios inter-relate," says Busch. "Some could prove critical to others, some might be time-sensitive and only triggered after others have occurred to other parts of the business. Whichever way, it gives a clearer sense of the path that events can take and a better understanding of the forces affecting procurement in general."

Former VP of global supply management at Unilever Dr Uwe Schulte agrees, "If it's done well, you get insights into your own developments as a group and you get to see things from the outside - which is a valuable perspective and one which will make you much better prepared."

"It should be considered as a tool which enables procurement to step out of the day-to-day and prepare for big changes," he adds. "If your business has a lot of areas of uncertainty, this is what you should think about before it develops into a problem, that way the preparation is in place."

A recent example is Eli Lilly. By identifying potential demand-side drivers and focusing on the potential effect of an R&D breakthrough or incremental innovations it was able to construct a series of scenarios and investigate how likely these were, what the outcomes would be and how different functions would behave.

However, strong though the argument is for spending time and energy on coming up with these scenarios on which decisions can then be made, difficulties lie in demonstrating the actual ROI of this kind of activity.

The original example of scenario planning is Royal Dutch Shell, which in the 1980s looked at ways it might cope with dramatic falls in oil prices. It's often cited that when this actually did happen toward the second half of the decade, Shell reaped huge benefits from the preparations it put in place as a result.

However, the other view frequently taken is that despite the work done by the scenario team, the key decisions the company took had more to do with sensible risk analysis rather than anything the research had uncovered.

Thus implementing scenario planning is a challenge in itself. One hurdle to overcome is getting the results of the process to have a tangible, recognisable effect on how functions behave. Identifying a potential supply risk early on is one thing, but whether it's possible to persuade the function to take time and resources to prepare for something that there's a very good chance will never happen is another.

Ulimately, Schulte points out, "It's difficult to communicate the value of this particular type of long-term risk analysis. Because it doesn't have quantifiable outcomes a lot of people have a problem with it. If they don't feel the pain within the organisation it's very hard to convince them why they should spend their time doing it."

Scenario planning also requires a different mindset and openness among team members, says Busch. "After all, all the hard work that goes into envisioning the future and rehearsing how to react to changes in the market will be for naught if an organisation is then unwilling to act on the recommendations and begin to monitor the environment around them."

So, whether you take the view that strategic planning is glorified risk assessment or a critical business strategy, it is likely to have an impact on the way companies look at their decision-making, particularly in a post-recession world.

Schulte notes, "It's amazing how many people say 'yeah it's important' and then don't do anything. They don't understand it, or they think it's tedious. However, you can always dissect things and take the time to learn if it's going to be useful for you."

As risk management moves up the agenda, the advantages of looking into the crystal ball are far too valuable to ignore, if you can just persuade those around you it's a good idea...

Procurement Tag - Risk Management