Why Planning Becomes More Important When Faced With Uncertainty?
Having written previously on ‘Planning in times of uncertainty’, Alan Gleeson revisits the subject given the continuing uncertainty we all face. His core argument in that article was relatively straightforward: that planning becomes more important in times of uncertainty, rather than less so. In this article he discusses how to cope with uncertainty.
As The Economist proclaimed in a recent edition (‘To forecast or not to forecast’, on 28th February 2009); “Precisely because peering into the future is harder today than it was a year ago, managers should be using every available means to gauge what the world could look like in the coming months and to establish targets using this analysis”. This view is, of course, in stark contrast to the perception by some that planning is ‘pointless’ when there is so much uncertainty. In this article, I want to suggest some further recommendations for managers seeking to effectively manage their businesses in an increasingly uncertain world.
Emergence of black swan events
The uncertainty we all face has been exacerbated in recent years by, amongst other things, globalisation and the growing interconnectedness of the world. These factors have contributed to the impact of ‘black swans’ as described by Nassim Taleb in his excellent book ‘The Black Swan: The Impact of the Highly Improbable’. The term ‘back swan’ is derived from the previously held assumption that ‘all swans were white’ until the discovery of black swans in Australia. The concept is not a new one, in economics, such black swan events are known as outliers, in that they sit outside the range of typical occurrences spread around a mean.
So what defines a black swan event?
Firstly, as Taleb describes, the probability of occurrence of such events is low (based on experience). Secondly, even though the probability is low, when one does come along the impact is significant. Finally, ‘no one saw it coming’ before the event, but after it happens, people claim that it ‘was inevitable’.
While some black swan events are largely positive (e.g., the invention of the Internet, the Harry Potter phenomenon), many more are negative (e.g., 9/11, the Swine Flu outbreak, etc.). However one thing is clear, these events can have enormous impact on us all. In a sense, the uncertainty we all face has increased dramatically.
So where does all of this fit into planning?
One inherent difficulty in planning — trying to predict future events — has always been with us. Whereas in some circumstances we can rely, in part, on the past as a rough indicator of the future, in many others we cannot. As I stated in a previous article on sales forecasting:
“Since time immemorial, people have sought to predict the future. Until the emergence of the relatively modern concept of ‘risk’ and the development of probability theory in the 17th century, predictions about the future had traditionally been the preserve of soothsayers such as Nostradamus. However, with probability theory, mathematicians demonstrated that one could use past indicators to make educated guesses as to the expected outcome of a particular set of events, e.g., the roll of a die. All these years later, and despite our progress, we still lack the ability to predict the future. Nevertheless, by considering various risks and probabilities, we can aim to understand some likely future scenarios to a greater degree.”
However planning and forecasting is not about trying to be 100% accurate. As business planning guru Tim Berry (Founder and CEO of Palo Alto Software Inc), has consistently argued ‘your business plan is always wrong’. Forecasting is validated by the reasonableness of the assumptions, and the accuracy or lack of accuracy thereof is not the test of the forecasting, as much as evidence of the need for it. Planning becomes a way to measure the difference between what was expected, and what ultimately happens and managing any resultant variances is a key element of the value of business planning.
The difficulty we now face however is that planning has simply gotten more difficult and, as I argued previously, has also become more important. Traditional models of planning where various case scenarios are considered is too limiting in certain environments. Models can no longer be limited to analysis of interest rate movements, exchange rate movements, oil price movements and assessments related to consumer demand. Strategic planning analysis has to include contingency plans related to more extreme events. As a recent McKinsey article claimed (McKinsey Quarterly, ‘Strategic Planning: Three tips for 2009’):
“In a highly uncertain environment, the advantages of scenario planning are clear: since no one base case can be regarded as probable, it’s necessary to develop plans on the assumption that several different futures are possible and to focus attention on the underlying drivers of uncertainty.”
In traditional models of strategic planning, the method often used to consider such uncertainty was to run ‘best case’ and ‘worst case’ scenarios. The key point I am making here is that this method assumes relatively equal probabilities of occurrence, whereas in an environment where black swans are becoming more prevalent we need to also consider bigger external shocks when we plan.
Take for example the newspaper industry. There have been numerous accounts of its impending demise, on the back of declining readership numbers (due in part to the increase in free substitutes such as the Internet). In May 2009, the well-known investor Warren Buffet declared that, “For most newspapers in the United States, we would not buy them at any price” as “they have the possibility of nearly unending losses. … I do not see anything on the horizon that sees that erosion coming to an end.” So what was a positive black swan for some, (the Internet), has proven to be a negative black swan for many (the catalyst for potential disaster for the newspaper industry).
Hence, the message here is once black swan events emerge, businesses need to be very clear as to the likely impact on their particular business and they need to have a robust plan as to how best to mitigate against any negative implications. Again this is where the value of planning becomes apparent. If actual results deviate significantly from initial projections, immediate corrective action needs to be taken. Indeed it could be argued that the newspaper industry has not yet gotten around to dealing with the Internet as a competitor/substitute.
An additional example of an external shock relates to the significant decrease in honey bees in the UK and US (in particular) as a result of Colony Collapse Disorder (CCD). The potential ramifications for us all are significant given the role bees play in pollinating many of the crops and fruit we consume. Häagen-Dazs is a good example of how affected companies can deal with the increased uncertainty, in this instance by trying to protect a key supplier, the honey bee. Häagen-Dazs set up a website ‘Help the Honey bee’ , which seeks to drive awareness of CCD by trying to influence people to play their part in ensuring their survival. The emergence of this CCD phenomenon most certainly constituted a black swan event in the eyes of Häagen-Dazs and hence, their attempts to reduce its impact have been both immediate and creative.
So what else can be done to plan through such uncertainty?
The following represents some measures that companies can take to plan effectively in times of increasing uncertainty:
1. Minimize downside risk exposure: All managers should encourage in-depth risk assessments so that risks are managed where possible, be it through the use of insurance products or strategic moves, such as reducing reliance on one key supplier.
2. Ensure planning processes are in place: Business planning and scenario planning need to happen more frequently within companies. Similarly, strategic analysis using models such as Porter’s Five Forces and SWOT analysis models need to occur more frequently than has traditionally been the case.
3. Build up a cash buffer: In uncertain times, it is best to convert stock and debtors into cash as quickly as possible. Increased defaults and growing numbers of companies becoming insolvent mean that all companies are increasingly vulnerable to bad debts. The old adage ‘cash is king’ is particularly important in uncertain times.
4. Encourage long-term planning: Businesses typically focus on a 1–2 year planning horizon. However, some emergent trends take time to diffuse throughout a market niche, so it is important to assess the likely impact of current trends on future consumer behaviour. For example, companies creating digital products will be affected over the medium term in various ways by the growth of mobile devices; the price collapse of CDs as music and video users migrate to DRM-free MP3 downloads, etc.
5. Ensure managers are plugged in to various information sources: Businesses need to adapt quickly in such fluid environments. Smaller, more nimble companies will benefit, provided they are able to take advantage of obvious emergent trends in their sectors before larger incumbents have time to react. Given the speed with which information disseminates in the Internet era management need to be cognisant of developments which will impact their business.
6. Flexible pursuit of emergent opportunities: Black swan events trigger winners and losers. For example, in the case of the recent swine flu outbreak, there were a number of beneficiaries. As Jacqueline Berry, spokeswoman for 3M (who make face masks), claimed, “We have increased our production, which includes adding shifts and increasing the number of manufacturing lines to meet demand.” Similarly, Roche, maker of Tamiflu, have seen a huge increase in demand for its flu drug . Companies need to remember that changing environmental conditions also bring opportunity and hence, businesses need to ensure that they are adaptable to meet these changing conditions.
7. Encourage Innovation: Entrepreneurship and innovation should be encouraged; provided the downside risk is managed the learning alone will be highly beneficial. Similarly the disciplining effects of a downturn help ensure that resources are not squandered as easily as in boom times.
8. Ensure adequate alert systems are in place: As the credit crunch continues to impact us all, contingency plans need to be put in place, in the eventuality suppliers or resellers fail. Companies need to ensure that simple alert systems are in place, such as having Google Alerts set up to trigger alerts for news stories related to key stakeholders, and suppliers. Similar warning systems need to be put in place to watch out for distressed companies, i.e., those where significant share price collapse is evident, or other noticeable trends are obvious e.g. payment delays increase.
9. Seek imaginative solutions: Finally, many of the issues arising from these external shocks or black swan events are quite challenging and a number of tough calls often need to be made. The use of tried and tested unimaginative solutions can often serve to exacerbate problems; for example, the increase in taxes initiated by countries such as Ireland in seeking to tackle the credit crunch takes cash out of the economy, serving to reduce consumption further. More creative solutions are needed to deal with the problems caused by these black swan events.
In summary, given the increased interconnectedness of us all, events in one location can quickly diffuse around the world with positive and negative effects in equal measure. Naturally, by definition, black swan events are difficult to predict; however, the aim of this article is to equip readers with a number of tools and ideas so they can ensure that when the next black swan event occurs that they are better prepared to deal with it.
And finally…
How do we reduce the number of black swan events?
In a recent Financial Times article, Taleb describes exactly how with his ‘Ten principles for a black-swan proof world’!
Originally published at www.alangleeson.com.
