Effective Planning & Risk Management in an Uncertain Business Environment

Effective Planning & Risk Management in an Uncertain Business Environment Risk Management & Scenario Planning Terry Harbottle University of Lethbridge Harbottle Consulting

Key Objectives of the Evening • Understand the purpose and role of scenarios in strategic planning and risk management • Understand the types of issues and problems for which scenarios are most valuable • Understand the basic methodology / process in developing scenarios Harbottle Consulting

A Framework for Integrated Risk Management Organization wide Strategic -technology & information - knowledge management -industry value chain transformation -business model Environmental Risk -environmental disasters -changing environmental regulations Operating Risks -distribution networks -manufacturing –gas processing Commercial Risks - new competitor(s) - customer service expectations - new pricing models - supply chain management Market & Credit Risk -price - interest & fx. rate -commodity price Risk Identification Impact Response Connectivity Harbottle Consulting

Strategic Management - Context Internal Resources, capabilities & competencies Forces (Little or no Influence ) The World Financial The Industry Communities Social Customers Organization Economic Suppliers Competitors Political Politicians Regulators Technological Factors & Actors (Some Influence) Environmental Harbottle Consulting

Scenarios & Planning … A History Do we need a strategic plan? Denial Acceptance Frustration Solution Integration Integration with strategic change management Leave it to the Kremlin The importance of looking ahead The rise of scenario planning The impossibility of predicting 1950 1960 1970 1980 1990 2000 Harbottle Consulting

Strategic Planning Process Goals & Objectives Mission & Values Strategic Options Strategy Development Implementation & Evaluation Vision Feedback & Learning Harbottle Consulting

Scenarios In Strategic Planning Future Business Environment (Scenarios) Vision Mission Goals Learning & Change Competencies Competition Harbottle Consulting

Scenarios in Strategic Management Process 5 Year Business Plans/Budgets Scenarios Business Environment Analysis Strategy Formulation Strategy Implementation Performance Evaluation Learning Management of Business Management of Change Harbottle Consulting

Why Plan? • Is the future predictable? • How do you think about the future? • How do you plan for an uncertain future? But plan you must … “Failure to plan is planning to fail” Harbottle Consulting

The Illusion of Certainty • “The phonograph is of no commercial value” Thomas Edison, 1880 • “There is no reason for any individual to have a computer in their home.” - Ken Olsen, President of DEC, 1977 • Internal sales forecasts for PCs for the 1980s: 295,000. Actual sales for PCs in the 1980s: over 25,000,000 - IBM, 1979 • “Anyone who thinks the ANC is going to run South Africa is living in cloud cuckoo land.” - Margaret Thatcher, 1987 • “They couldn’t hit an elephant at that dist…” - Last words of General Sedgewick, 1864 Harbottle Consulting

The Challenge of Uncertainty • Who would have guessed? • The rise of the Internet? • That long distance telephone calls would cost 5c per minute? • That electricity would be deregulated and unbundled? • That the “Standard Oil Trust” would be reunited? • That a WTO meeting would lead to passionate riots? • That Nortel faces de-listing from the NYSE? • That Enron would vanish in 6 months? • Recent Geo- political events The future is not predictable, yet we must make decisions & act. Harbottle Consulting

Decisions and Consequences “…Strategic planning does not deal with future decisions but with the futurity of present decisions…” —Peter Drucker Harbottle Consulting

1970s Oil a declining resource $100 / bbl inevitable 1980s Electricity demand growth 1990s Mexican growth expected Japan recovery Asian growth inevitable Internet business 2000s Electricity & gas prices Technology “bubble” Ethics & Leadership Shale Oil Barents Sea Nuclear ’94 Crash Barings demise Thailand AOL/ Time Warner California / Alberta Dot.com Collapse Enron / World Com Expectations and Decisions Harbottle Consulting

Future Uncertain Range of Futures Insight Robust Strategies Two Perspectives on the Future Decisions based on Expectations Future Predictable Consensus Future Accuracy Optimal Strategy Harbottle Consulting

Predictability & Uncertainty Uncertainty Degree Scenario Planning Forecasting Predictability Time Harbottle Consulting

Scenarios… Examine Alternatives Wildcard Scenario X Today Scenario A Area of Plausible Futures Scenario B Scenario C Wildcard Scenario Y Area of Implausible Futures Today Tomorrow Harbottle Consulting

Scenario Planning ‘Risk Management and Opportunity Identification at the Strategic Level’ Harbottle Consulting

A Scenario Is... A story, an image, or a map of the future and An interpretation of the present projected into the future and An internally consistent story about the path from the present to a future horizon Harbottle Consulting

Scenarios = Alternative Futures • Multiple • views with different logics • Qualitative • dealing with complex structural change • Objective • plausible and internally consistent descriptions • Focused • key issues and uncertainties • Open-ended • outlines, not precise details Harbottle Consulting

Scenarios Involve Outside-In Thinking Resources, capabilities & competencies Forces (Little or no Influence ) The World Financial The Industry Communities Social Customers Organization Economic Suppliers Competitors Political Politicians Regulators Technological Factors & Actors (Some Influence) Environmental Harbottle Consulting

Scenarios and Systems Thinking Systems Scenarios The Story Visible Manifestations Events Characteristics & Storylines Trends and Combinations Patterns Causal Relationships Scenario Logic Structure Harbottle Consulting

Scenarios - Part of a Strategic Process Key Strategic Issues Focal Question Scenario Development Implications Strategy Development Harbottle Consulting

Value of Scenarios • Shared articulation of alternative futures • Coherent “mental maps” of the future • Analysis of current environment • Context for developing and evaluating strategy • Encourage adaptation to change • Emphasize uncertainty and the need for flexibility Harbottle Consulting

Features of a Good Scenario • Plausible • Recognizable from the signals of the present • Creative in exploring new ground and ideas • Relevant and significant to the organization • Internally consistent • Challenging Harbottle Consulting

Developing Scenarios 1. Focal Issue 2. Key Factors 3. Environmental Forces 8. Early Indicators 5. Scenario Logics 4. Critical Uncertainties 7. Implications 6. Scenarios Harbottle Consulting

Scenario Process in Pictures Forces Uncertainties Characteristics Paths Harbottle Consulting

Scenarios Ask the Right Question... “The only relevant discussions about the future are where we succeed in shifting the question from whether something will happen to what we would do if it did happen.” Arie de Geus Shell Group Planning Harbottle Consulting

Key Points • Scenarios are descriptions of alternative futures • Scenarios are focused on key issues and uncertainties facing the organization • Scenarios are the output of an interactive and creative process designed to gain insight not prediction • Scenarios are part of a larger strategic process contributing to enhanced strategic thinking, learning, and decision making • Scenarios planning is particularly valuable in turbulent environments facing structural change Harbottle Consulting

Future of the Railway Industry – A Case Study The purpose of this case study is to provide an example based on a real scenario project. It is not a model case. Timing and logistics force modifications in the 8-step process. Some worked, some didn’t. All were valuable in learning more about the challenge and reward of developing and applying scenarios to organizations. The viewgraphs to follow trace through each step in the process. Harbottle Consulting

Is a Railway Example Relevant? • The railway industry has a number of distinctive characteristics. Do these have any relevance to other industries? • The industry is very capital intensive • The industry is concentrated into a small number of major companies and independents • The industry is driven by the economy and subject to political intervention • The industry competes across RR’s and with other “modes” (e.g. truck vs. rail) both domestically and internationally • The industry is increasingly impacted by technological change and lack of skilled workers • The industry has much to learn from the experience of others Harbottle Consulting

Scenario Interview Questions What are the issues on the minds of managers? What are the strategic issues the scenarios should address? Try some of these questions in your company. • Past Changes – What has changed over the past 10 years that has had a significant impact on the industry / company? • Lessons from the Past – What has made the company successful in the past?What lessons do we need to remember? What do we need to forget? • Current Constraints – What things need to be changed for the company to be successful in the future? What are the barriers to innovation and change? • Critical Decisions – What important decisions are on the immediate horizon? What important decisions are being ignored that should be addressed? • Dark Spot – There is a dark spot on the horizon. It is not here and now but could have a major impact on the company / industry in the future. What is it? • Good Future – If you looked back 10 years hence and the company had been very successful, what went right? What does a good future look like and what needs to happen for that good future to occur? • Oracle – If you could spend time with an oracle or clairvoyant who knew the future, what question would you ask? What would you really like to know? Harbottle Consulting

Developing the “Focal Question” The focal question identifies: • The key strategic issue facing the company / organization. • The key decision facing the company. • The key question you would like to answer. The focal question should: • Focus on the company specifically (not the future of the world). • Highlight the key strategic question (e.g. growth, profitability, industry structure, competitive position, customer relations, etc.). • Focus on a single concern (not compound issues). Examples • How can ABC penetrate and gain dominance in market W? • How can LMN maximize growth opportunities? • How can XYZ strengthen customer relationships? • How can increase long-term profitability? Harbottle Consulting

Interviews & Focal Question - RR Example • Issues Emerging from Interviews • Railroad mergers • New transport regulation • New trade flows • Truck competition • Agricultural policies • Customer industries (coal, paper, grain, steel, autos) • Union power • Focal Question • Can Railco improve its competitive position and capture growth? Dilemma: Short term cost or long term growth? Unable to resolve. Harbottle Consulting

Factors and Forces All organizations are embedded in a larger context. The accompanying chart distinguishes the contextual environment (forces & factors) from the transaction space (actors). A key step in scenario development is to identify the forces driving change in the external environment. One approach in identifying major driving forces / factors in a workshop involves 3 steps. • “Take 4 or 5 minutes by yourself and identify 4 or 5 factors or forces (no real distinction is needed) which could impact the focal question.” • Go around the room and have each person describe the forces / factors they identified. Summarize to 4 or 5 words and write them on large post-it notes. • Using volunteers, sort the post-it notes into clusters around common themes. Do not use a pre-defined framework. Select notes randomly and look for another with a common connection, etc. Build up between 7 and 10 clusters. There should be no more than 10 post-it note ideas per cluster. Name the clusters reflecting the underlying theme. The cluster themes may be interpreted as the “forces” driving future change. They also represent a framework for describing the future. Each “force” must be included in all of your scenario descriptions although with varying interpretations and importance. Harbottle Consulting

Context of the Firm Forces (Little or no Influence ) Contextual Environment Financial Transaction Space Social Suppliers Customers “Firm” Economic Competitors Communities Political Regulators Politicians Technological Factors & Actors (Some Influence) Environmental Harbottle Consulting

Process Brainstormed factors and forces Grouped into clusters Clusters labeled to reflect major theme / force Factors & Forces(from clusters) Macro-economics Global / Asian growth Rail performance & competition Customer industries Rail industry restructuring Truck competition Labour Regulation & Politics Ports & Water Environment Key Factors & Forces - RR Example Harbottle Consulting

Importance and Uncertainty Forces Importance Uncertainty ______________________ ______________________ ______________________ ____________________________________________ ______________________ ______________________ ______________________ ____________________________________________ ______________________ ______________________ ______________________ ____________________________________________ This chart shows one approach to identifying “critical uncertainties”. These are forces which are both important and uncertain. Uncertainty means either that they have a wide range of possible outcomes, and hence are uncertain, or the impact of the driving force has a number of different possible impacts (e.g., technological change may be uncertain because there is a range of possible new technologies OR because the impacts on society are highly uncertain) The task is to rank (or rate) the forces on importance and uncertainty. This can be done in a group by allocating votes among participants (e.g., 3 votes for each participant) or by rating each force (1 – 5 scale) to identify the two which are most important and uncertain. The vote should narrow the choice but you should leave room for discussion before selecting 2 forces as the critical uncertainties. Harbottle Consulting

Critical Uncertainties - Rating Importance & Uncertainty Participants allocated 5 votes each for importance & uncertainty Importance Uncertainty Macro-economics 6 14 Global / Asian Growth 3 2 Rail Performance & Competition 8 0 Customer Industries 11 6 Rail Industry Restructuring 5 4 Truck Competition 3 1 Labour 4 6 Regulation & Politics 2 9 Ports & Water 2 1 Environment 1 2 Harbottle Consulting

Critical Uncertainties - Refining the Definitions • Macro-economics (rate and structure of growth) was immediately identified as a critical uncertainty; Global / Asian growth could be incorporated into this dimension. • Customer industries was a second candidate, but this appeared to be closely linked to macro-economics / growth • Was rail performance and competition predetermined (I.e. zero uncertainty)? When we unpacked this cluster it became evident that performance pressures were “inevitable” but not so clear. • A second critical uncertainty emerged around competition and industry structure, which appeared interesting and challenging. Harbottle Consulting

Example of a Cluster Rail Competition and Performance • Improving asset utilization • Railroad reliability • Seamless intermodal service • Ability to handle information • Rail track / operation separation • Seasonal operating difficulties • Rising customer expectations • Increasing rail to rail competition • Move to schedule services • Info systems in railroads A wide array of factors grouped into a single cluster Clusters help focus the process but can suppress critical factors Harbottle Consulting

Scenario Logics The dimensions are the critical uncertainties: label the 2 axes. Then describe the ends of the spectrum (2 – 3 words or phrases) Harbottle Consulting

Scenario Logic Framework - RR Example Restrained Competition Market Power Scale & Consolidation High Growth Global Technology Productivity Low Growth Volatile Nationalistic Interventionist Economic Growth & Structure Ind. Structure Competition Open Competition Customer Driven Market Share & Open Access Harbottle Consulting

Scenario Names & Characteristics Harbottle Consulting

Scenario Logics - Railway Industry Restrained Competition Dinosaur Park Riding the Momentum • Global Trade • Consolidation • Bulk commodities • Contraction • Stable Regulation • Excess Capacity Economic Growth & Structure High Growth Low Growth Industry Structure Competition Technology Forced Stagnant Growth • Customer Demands • Seamless Service • Internal Pressure • Desperate Customers • Nationalistic • Interventionist Open Competition Harbottle Consulting

Other Examples – NA Mining High Growth Prices & Productivity New Horizons Money Divides Open Inclusive Holistic Trust Respect Closed Divisive Conflict Distrust Self-Interests Societal Values Economic Performance Perfect Storm Phoenix Rising Low Growth Prices & Productivity Harbottle Consulting

Other Examples - Future of NAIT Open Competition PROZACTIVITY COMPETITIVE EDGE • Political conflict • Government directed • Public driven • Education controlled • Open markets • Consumer driven • Expanded training • Leading edge technology Public Private • Government driven • Social Responsibility • Stability • Education Integration • Corporatist • Business driven • Partnerships • Structured Learning CONTROLLED GROWTH DALLAS Limited Competition Harbottle Consulting

Developing Storylines Scenarios are stories, engaging, logical and challenging. Stories need a plot through time. One way of developing the story through time is to have participants describe events consistent with the scenario logics in 3 time frames: near term, medium term and long term. Writing these as newspaper headlines is one approach which can add fun and creativity to the exercise (but can become trivial if you are not careful). The descriptions should reinforce the overall logic of the scenario. They provide useful material in writing the stories and in developing material. A useful tool in developing the logic and story of a scenario is to map out the logic. An example of a “logic map” for the railroad scenario “Riding the Momentum” is shown in the next viewgraph. Harbottle Consulting

Logic Map for “Riding the Momentum” Rail Consolidation Global Growth Restrained Competition Lower Costs & Market Power Rising Transport Demand Increased Profitability Increased Investment Ship / Rail Technology Mapping the logic helps in developing the story through time Growth in Truck Traffic & Profits Long Haul Focus Constrained Competition Harbottle Consulting

Writing & Communicating Scenarios Scenario writing is an art. The written scenarios are intended to engage the mind of the reader. To draw them into the future. To encourage them to explore new ideas. To think differently. The stories must be logical, internally consistent and believable. The writer does not need to think through every detail. Indeed, this is counterproductive. The scenarios are necessarily incomplete to let the reader add ideas and examples from his / her experience. There is tremendous opportunity to be creative in writing scenarios. Experiment. Try new things. Some have used dialogue; some have used “newspapers”; some prefer “bullets” to written prose; some have written in the future tense, present tense and past tense. (I prefer the past tense because stories seem more real and believable when written as if they have already occurred. ) Some include the logic leading up to the critical uncertainties in their reports; some include an overview before the stories (my preference); and others plunge right in. Some include both stories and “bullets” using a “summary comparison table” to encourage comparison across the scenarios (see next viewgraph). Scenarios should be grounded in recent events. The same event(s) may appear in all scenarios but with different interpretations leading to distinctly different futures. This links the future to alternative interpretations of the present and anchors the stories in reality that readers are currently experiencing. Written documents are only one form of communication. Presentations are another form. Others have developed videos; and others have used actors to bring the scenarios alive – literally. The only limit is writing and communication is your imagination (and budget). Harbottle Consulting

Summary Comparison Table Characteristics Scenario B Scenario C Scenario A Scenario D Tech Impact +++ + - - 0 Rapid Protection Slowing Stable Globalization Growth Prices Volatile Flat Rising Falling Regulated Free Mkt Reregulated Regulated Policy Authoritarian Liberal Tolerant Intolerant Values Harbottle Consulting

Effective Planning & Risk Management in an Uncertain Business Environment