March 11, 2012, marked the one-year anniversary of the devastation caused by an earthquake off Japan’s northwest coast, which created a tsunami that destroyed several coastal towns. It also triggered the events that resulted in terrible nuclear disaster when the Fukushima Daiichi nuclear plant got out of control. This disaster led to severe reductions in Japanese power generation and to the world rethinking the future reliance on nuclear power. It was what has often been called a Black Swan event (while known to be possible, considered highly unusual).
Unfortunately, this was not the only Black Swan event of the last 14 months.
- Flooding in Thailand has severely impacted global supply chains particularly in the automotive sector.
- The seemingly rare occurrence of active volcanic ash being spewed into the atmosphere and endangering aircraft returned but this time to the Southern Hemisphere, impacting Australia, New Zealand and large portions of South America and southern Africa.
- The Arab Spring continued political turnover in many Arabic countries has created uncertainty for oil supplies and for the domestic populations.
- The potential for the European Community to come apart continues to reappear as first Greece, and then Portugal and potentially Italy and other countries flirt with sovereign debt defaults.
I could continue at the risk of further depressing you. The question these issues raise is: How should a company plan when the world has so much uncertainty? How can you be ready for these divergent possibilities?
Fortunately, we have learned some ways that organizations are using to cope. At the upcoming 11th Annual Beyond Budgeting Conference, Dimensional Fund Advisors CFO Dave Martin will share how his organization uses scenario planning to prepare, even for Black Swan events.
You may recall that Martin was the subject of one of my past CFO interviews. Martin is the former CFO of Janus Capital Group, and has worked for Charles Schwab, Interstate Bank of Texas and Texas Commerce Bank. He has worked with both booming new enterprises and the aftermath when the bubble bursts. In drawing on his diverse work background Martin has seen what truly best practices are across all industry and in any phase of an economic cycle.
During the latest financial downturn, Dimensional Fund Advisors was able to navigate the downturn without any layoffs. They achieved this by using scenario planning as a normal part of their planning routine. Rather than follow the typical path of negotiating and annual budget, they couple their financial plan with a set of scenarios that consider both opportunities and risks to the expected course of "normal" operations. They routinely ask:
- What would be the impact of different potential events such as those noted above?
- If they occurred, what actions could management take to seize new opportunities or defend against potential risks as they present themselves? These actions are sequenced and used to create a "playbook" that speeds management’s ability to react.
- What leading indicators provide early warning that a risk or opportunity is becoming more likely to occur? Leading indicators keep you aware of how quickly things can develop and keep you diligent in looking for changes. These go for the opportunities as well as the threats.
In creating these scenario plans, management also considers not only the change in business conditions but also how long they are expected to last. You will have a mild reaction to a cold snap that warms right back up. On the other hand, a prolonged chill requires a much stronger response. This is where discussion of a new normal comes in.
Dave Martin will be speaking at the 11th Annual BBRT Conference, April 18-20, in Houston, Texas. Click here for more information on how you can attend.
