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Peter Upapong

7 Essential Lessons in Scenario Planning

Updated: May 21, 2020

Unprecedented.


Given today’s crisis, the word ‘unprecedented’ is on the lips of many CEOs. I would be comfortable to take a bet that on the majority of upcoming earnings calls and annual reports, this word will be used over and over again.


Unprecedented means never done or known before.


I do not want to underplay the harsh reality of what is happening today and those that are suffering and have been lost, and while ‘unprecedented’ makes a great catch all for “hey we will definitely be missing our numbers,” and “please can we adjust your (the Street’s) expectations,” the reality of the word unprecedented uncovers a further truth which is being unprepared. Not only in tests, tools, but in mindsets.


The other reality is ‘unprecedented’ doesn’t mean infrequent.


Back in 2007, I was working in Finance for one of the largest banks in the world. My CFO had tasked me and a very small team to do something unprecedented. In a very short amount of time, 2 weeks, create a new strategic planning model to address some startling dramatic indicators.


The vision for the model was to be strategic but comprehensive – all 3 key financial statements working in harmony. Unconstrained by the construct of existing strategic planning models and leveraging all of the c-suite and their teams as needed as the highest priority.


So we proceeded to lock ourselves in a meeting room with no windows, multiple large screens mounted on one wall, and large whiteboards that covered the other 3 walls. We would book all day meetings to reserve the room as “The War Room.”


If you trace back scenario planning, the first major modern instance of this (as with many things) was in the military. The US department of defense was preparing for what would turn into the Cold War. Herman Kahn was a young defense analyst and started developing an approach often characterized as “thinking the unthinkable.” By the 1970s, scenario planning was adopted into industry first by Pierre Wack of Shell Oil. Scenario planning allowed Shell to be alerted ahead of things like the 1973 oil crisis and collapse of the oil market in 1976. (1)


Back to my “War Room.” As we ideated, prototyped and iterated in those first days we learned many things that would become the


1. Foundational guiding principles for financial strategic and scenario planning modeling


  • It had to have a Balance Sheet, P&L and Cash Flow with natural connection points.

  • It had to provide near-term actionable details and long-term perspective.

  • It had to be indicator or driver-based – with a place for drivers and assumptions, clear on how does it calculate, and clear outputs that you could tie back to drivers and would permeate through the model.

  • It had to be straight-forward enough that anyone, including ‘C-Suite’ could run it end to end without the help of a business/finance analyst or IT resource.

  • We had to make sure key financial metrics could be calculated (e.g. profitability, efficiency ratio, % of loss reserve to portfolio balance, etc.)

  • It had to be easy to feed real data (e.g. actuals, risk delinquency and charge-off curves)

  • It had to work over and over again – scenario after scenario (seems obvious but very difficult when you are not aware of what type of scenarios would be needed)

As the model began to take shape, we then pulled in key folks from risk, strategy, finance and an entire host of other characters. Their role was to not be additional ‘cooks in the kitchen’ but be a sounding board to look at our new model, look at their existing models, poke holes, share ideas and it was up to our small team to decide to include it or not.


2. Your worse-case scenario is too optimistic.

When we started, we purposely started with sensitivity analysis, why? Because it was easy. It was pure math. But we knew that the simple downside scenario lacked the creativity and sobering reality of a true worse-case scenario, so we knew there was much more work to do. Today, one of my former teammates kids me all the time that we did “true Stress Testing before it was cool” (and required by federal mandate).


Humans tend to be optimistic. Often, when you set a plan, the plan is usually about how I succeed based on my current understanding of the world and what activities and milestones I need to reach this goal. Why is this the case? Why are we so optimistic?


One theory published by scientists from NYU found that

"(there is) a neural network that may generate the human tendency to be optimistic…As humans, we expect to live longer and be more successful than average, and we underestimate our likelihood of getting a divorce or having cancer…” (2)

While this is not the case for those suffering with depression, most humans are likely hardwired to be optimistic and as such the hardest thing to do is to challenge everything you know about success, history, and your own experiences to change your own mindset.


So think about your worst-case scenario for your organization.

  1. What if the supply side is severely constrained or completely cut-off? What if your primary suppliers go out of business? What if your suppliers demand you to pay sooner?

  2. What if there is no demand from your customers, or you lose customer favor or your customer is unable to buy? Is your product essential during a time of crisis? What if a disruptive product or service that solves the problems that your customer is begrudgingly tolerating enters the market?

  3. How much cash do we have and how long will it last if we completely stop generating new revenue? If we needed to, how easily could we convert things to cash or raise debt? Who would lend to us? How do we position our investments and capital for a scenario of recovery when a recovery date is uncertain?


These are all are key questions but based on conversations with fellow leaders #3 has become a focus area during the current crisis and underpins the next thing I learned.


3. The undisputed heavyweight champion of the world and still the King - Cash.

Many of the strategic planning scenarios we ran at the bank were focused on preserving cash. It is almost cliché now in tech, think Facebook, Uber, Spotify all survived and thrive today without profitability but with boat loads of cash.


Even if your company is not profitable, if it has hope (in the form of cash and sentiment) from investors, debt options, and/or revenue streams, you can survive and potentially grow.


This is how Amazon survived the dot-com bubble. There were 2 things that Amazon had going for it and both centered around cash.


First, how they managed the Cash Conversion Cycle.


The cash conversion cycle is:

Days Inventory + Days Receivables – Days Payable


Days Inventory = How many days of inventory are we holding?

Days Receivables = How many days is there between when our customers buy and when we get paid?

Days Payable = How many days from when we buy from our suppliers and need to pay them?


For most companies the difference (usually a positive number) represents the gap that is required to be covered by treasury cash reserves or debt. Amazon had a negative cash conversion cycle. Very small number of days inventory held. At the time, most sales were retail and paid by debit and credit cards, so consumers were paid nearly immediately. Finally, they had credit from suppliers of approximately 30 days. This means, Amazon was paid by customers for inventory before it had to pay suppliers. (3)


Secondly, they padded the war chest based on scenarios in preparation for a looming recession.


As detailed by Jeff Bezo’s biographer Jeff Stone:

"Early in 2000, Warren Jenson, the fiscally conservative new chief financial officer...decided that the company needed a stronger cash position as a hedge against the possibility that nervous suppliers might ask to be paid more quickly for the products amazon sold...so in February, Amazon sold $672 million in convertible bonds to overseas investors. This time, with the stock market fluctuating and the global economy tipping into recession, the process wasn’t as easy as the previous fund-raising had been. Amazon was forced to offer a far more generous 6.9 percent interest rate and flexible conversion terms — another sign that times were changing. The deal was completed just a month before the crash of the stock market, after which it became exceedingly difficult for any company to raise money. Without that cushion, Amazon would almost certainly have faced the prospect of insolvency over the next year.” (4)

4. The best scenarios are built on two key pillars: analytics (reality) and imagination.

When I first talked to the risk team, the curves provided were as expected - quantitative, substantiated and steeped in reality. Then my CFO and team began to question and challenge assumptions. What if they were worse? What if delinquencies and charge offs spiked so high that regardless of how seasoned the portfolio, you would want or rather need to apply a much more severe risk curve against it.


When building scenarios, you need to continually step back and say, what assumptions am I taking here, is there potential for things to be much worse? And to not be all downside doom and gloom, but also what if the market is much greater than we realized? What if we are leaving money on the table?


Cue IBM. I won’t go into much detail here, but this is part of the fabled story about the forecast by IBM that said the personal computing market would be relatively small. So, rather than investing they gave software to a guy in a garage in Seattle and the chip production to Intel. They left $200 Billion+ on the table, not because they were not smart, but the forecast lacked imagination.


5. Scenario Planning is less about Prediction and more about Preparation.

When we build scenarios, we are creating maps. These maps help you prepare for uncertainty and when those tipping points, inflection points, or any other kind of alarms go off. Then we will be able to act because we are prepared. We will be able to say, “We have seen this before in that model, this is what we must do.” This is where phone tree calls for business continuity meet strategic thinking.


We are always searching for predictions. That is why the ‘psychic services’ (yes, Psychics/Mediums) industry was $2.2B in 2019 and the predictive analytics services industry is project to be $24B by 2025. Predictive and prescriptions capabilities are powerful tools that planners are actively using today. These capabilities allow you to plan faster. Period.


More so, they allow you to model things you would regularly not have time to do. The power in the predictive capabilities is to have the ability to run more scenarios and make better decisions. This is where true planning and business value is created.


6. To solve difficult problems or to make a robust scenario plan. Empower small cross-functional cross-discipline teams and give them the platform to do unprecedented things.

There was mainly 4 of us. Each person including myself had done most roles across finance. While our levels in the traditional organization were all over the place, we all brought unique perspectives and were not afraid to question and rip underlining assumptions with a level of psychological safety in the sacred “War Room.”


The leading thinking in management shows the decentralization of decision-making. Companies like Haier (large appliances and consumer electronics) and Tencent (conglomerate – internet, AI, gaming, and the list goes on) have taken over tremendous market share (and cash), in their respective eco-systems.


Similar to Amazon’s, “two pizza rule,” where project teams cannot be greater than those that are able to eat 2 pizzas for dinner comfortably, these companies are doing innovative things and it is paying off.


Tencent Gaming has done the following:


  1. When working like a ‘Brain Trust’ to ideate, they remove power from the room so the least powerful person feels safe to talk.

  2. To drive internal and external engagement, they look at actions and behaviors vs. values.

  3. They attempt to avoid undervaluing the unseen and overvalue what they know in the ongoing pursue of what they don’t know.

  4. When they act or take a decision after scenario planning, they make it about choice and not the unwilling enforcement of best practices. (5)


With this mindset, they took major business units and broke them up to smaller studios and empowered the small and agile teams to make decisions without approval from the ‘mothership.’ They cultivate ownership and entrepreneurship by giving everyone ‘skin in the game’ with a clear revenue sharing model. They leverage their scale and size to provide connected and shared platforms and tool sets to enable collaboration.


7. If a worst-case scenario plays out, act swiftly and with perspective to “stop the bleeding for everyone.”

People usually talk about empathy when cost optimizations and lay-offs are required. While empathy is critical, it is also about transparency, honesty of failures by leadership, and the pursuit of preservation of dignity for those impacted.


You hear many organizations out front saying they see crisis as an ‘operational exercise.’ This is what you should be targeting. That if something happens, you have a playbook to know how to act. To allow lessons to be learned via experience is a costly one for organizations and for people. Scenario planning is cheaper.


Reading an excerpt of JP Morgan Chase’s FY19 Annual Report and letter to shareholders from Jamie Diamond (Chairman and CEO), best encapsulates this thinking,


"Entering into a crisis is not the time to figure out what you want to be. You must already be a well-functioning organization prepared to rapidly mobilize your resources, take your losses and survive another day for the good of all your stakeholders.

Before the peak of the financial crisis, our scenarios from our strategic models became the models that fed into the forecasts and budgets. With our scenarios and analysis in hand, our C-Suite took the difficult decision to end any new lending and subsequently laid off over 5,000 people – primarily in the sales force and branches. As our CFO prepared our broader team for the announcement, Finance and HR stood out as a clear leaders to ensure severance and post separation services were clear and properly in place.


This is why scenario planning and transformative thinking is so important. A company, a community, and a world may survive, grow or fail based on the culture and mindset of its people. The future will continue to present unpredictable things. But it is our imperative and responsibility to mitigate unprecedented as much as possible.


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