In an Uncertain World, Plan to Be Wrong

It's early December 2010 and the executive team of an airline is looking to wrap up its 2011 plan. Not surprisingly, a key assumption in the plan was tied to future oil prices. Throughout the fourth quarter of 2010, the price of oil was between $75 to 85 a barrel. With forecasts for relatively slow economic growth in 2011, management settled on an assumption of $78 for the year. Their comfort level increased when the head of supply chain at a logistics company is quoted by the media predicting a similar price per barrel. Unfortunately, by mid-February Brent crude prices had topped $110 a barrel and the company's budget was in tatters. A frustrated executive team wants to know what it can do to plan more effectively.

The first thing the management team needs to accept is that no traditional budget can withstand a 40 to 50 percent change in a material assumption. In today's volatile and uncertain world, the situation the management team faced is no longer a rare occurrence. Nearly every organization has to deal with unexpected material changes to key budget assumptions as a result of rapid changes in key input prices or the impact of material external events whether it's a natural disaster, such as the earthquake in Japan, or the downgrading of U.S. government debt.

In the face of such uncertainty, executives are looking for tools that can help them plan with greater confidence. The result is a very different process than the traditional annual approach to budgeting, quarterly forecasting and monthly reporting. Today, in an era when the constant is change, four attributes should be part of the process:

1. The expectation that assumptions will be wrong
2. An early warning system
3. Real-time analytics capabilities
4. Ability to act with speed and confidence

Expect to Be Wrong

It's naïve to expect an annual budget to remain relevant for very long. Today, the only constant is change. Use the budget to establish baseline resource allocations and performance expectations but not as a month-to-month scorecard for the business. Traditional budgets often contain far too much detail under the mistaken assumption that the more detailed the budget, the more accurate it will be. When there is great uncertainty around certain aspects of the budget, sacrificing detail for flexibility by developing alternate scenarios that map out how resources and performance will change under different sets of assumptions is key. One leading financial services company eliminated 60 percent of its budget line items and re-directed effort towards developing alternate budget views under different assumption sets. Having identified alternatives, executives can more rapidly respond to changing market forces. As a CFO once commented, too many extra details in a budget creates variances without contingency plans. In today's world, defining contingency plans can make the difference between winning and losing in today's marketplace.

The integration of scenario and contingency planning techniques into the budget and forecast process positions an organization to react with speed and confidence when the unexpected occurs. While the logistics company mentioned earlier developed their initial baseline budget using a $78 a barrel oil price assumption, they also developed a scenario that envisioned oil prices at $140 per barrel so the rise to $110 was well within the range of what they had considered despite the inaccuracy of their original assumption. Anticipating change in key planning assumptions is an essential pre-requisite for agile decision-making but it's not everything.

Develop an Early Warning System

When your car is running short on gas a warning light comes on to prompt you to fill up. The warning light does not illuminate when the tank is empty and it's too late to do anything about it; instead it gives you plenty of time to consider alternative courses of action, make a decision and act on it. In today's competitive, global markets, early warnings are vital, yet many organizations still rely on backward-looking information that offers little insight into the future. High performance organizations aggressively seek out data that can provide insights into future behaviors of markets, customers and competitors. Appliance makers study data on new housing starts; telecom equipment makers look at internet usage patterns and smart phone adoption rates; while healthcare organizations study dietary trends amongst many other datasets. However, today that's not enough.

One of the characteristics of the post-2008 global economy is that patterns are not uniform—different markets, sectors and geographies are performing in very different ways. Germany has recovered well, while near neighbors Italy and Spain struggle with sovereign debt burdens. Canada's financial system is much stronger than that in the U.S.

Organizations need to scan the behavior of leading indicators much more frequently and in a more granular way. Instead of looking at unemployment numbers as a predictor of consumer spending once a year during the annual planning process, trends need to be scanned monthly or quarterly. Savvy restaurateurs now review new restaurant opening plans on a monthly instead of semi-annual basis to ensure that local market conditions still justify investment in new locations. Similarly looking at macro trends no longer provides enough visibility to the material differences between individual markets. GDP estimates at a national level mask the very different performance characteristics of different sectors or geographies.

Most important of all, an effective early warning system buys management the most precious commodity of all—time. Time to understand, interpret, plan and act.

Deploy Real-Time Analytics

In a world where budgets and forecasts become obsolete almost as soon as they are created, Finance needs to move beyond simple variance analysis. The increasingly rich data that is now available offers tremendous opportunities to deploy sophisticated analytic tools to better understand current and likely future performance. Finance needs to help business leaders address key questions such as:

• Which business drivers will have the greatest impact on future growth and profitability?
• How can we anticipate and influence changing market conditions and customer behaviors?
• How should we optimize investments across our products, geographies and marketing channels?
• Are the changes in customer buying patterns that are emerging indicative of a major shift in future behavior?

Aligning analytics with key decisions is a critical step in integrating rich insights into the decision-making process. For example, real time analysis of first weekend box office numbers for movies provide studios with rich insights that can alter distribution and marketing strategies in real-time. If the analysis took two to four weeks to complete, it would be worthless; the opportunity to act to materially impact performance would have been lost. Finance must collaborate with marketing, sales and operations to apply analytical rigor to key decisions and also lead the study of the likely financial impact of changes.

This cannot be a leisurely process of exchanging spreadsheets over a period of days and weeks; it needs to be event-triggered and offer real-time answers to four key questions:

1. What is happening?
2. Why is it happening?
3. What are the implications for our business?
4. What action (if any) should we take?

Finance needs to ensure that all the analysis it provides answers all four questions in a timely fashion and equips business managers with the knowledge to act decisively.

Act with Speed and Confidence

It doesn't matter how effective your performance management process is if business managers are unwilling to make decisions. In times of uncertainty and volatility, decisiveness becomes even more important yet the response is often the exact opposite. Managers become hesitant and cautious, unsure of what to do. Opportunities for profit maximization or loss mitigation are transitory and any hesitancy in acting can be expensive. Historically, much of the analysis conducted by finance has been wasted. The results are not shared with critical decision-makers or the analysis is available too late to be of use in today's fast-moving business world. Finance's role is to ensure that managers feel confident in even the most uncertain times by ensuring that:

• Decisions are being made using the best available information
• Information is delivered directly to decision makers—providing time for considered analysis, discussion with peers and reasoned decision-making.
• The consequences of being wrong are clearly understood
• Effective scenario planning (what-if analysis) provides insight into the range of likely outcomes while also offering options for changing course downstream if needed
• Decisions that turn out to be wrong will be quickly identified using the early warning system thereby minimizing the negative impact and maximizing the time available to take corrective action.

Organizations that effectively combine these four attributes are well positioned to navigate more effectively in turbulent times. While consistent, profitable growth is not guaranteed, organizations that exhibit these attributes are more likely to outperform their peers in both good times and bad. Finally, don't be blindsided by volatility; embrace it, for the opportunities it creates.

David A.J. Axson is a senior executive in the Finance & Performance Management group at Accenture, a global management consulting, technology services and outsourcing company.