Scenario planning has long been a key part of an organisation’s strategy conversations. It is especially important in times of extreme volatility, and the coronavirus outbreak is one of those times. David Axson has spent 35 years focusing on strategy and scenario planning, including work as a consultant to CFOs and other finance leaders, writing, and speaking around the world. He shared some steps organisations can take in the short term, and thoughts on the long-term value of planning for a serious event, in a Q&A last week with FM.
The coronavirus outbreak has proved a big test of companies’ ability to handle what really is a globally challenging crisis. What are you seeing companies do well? And what could they improve on?
David Axson: I think it’s a really interesting time because this is just the next in a series of events that we’ve had like this, that (a) emerge and scale rapidly and (b) are potentially very severe in their impact. And we can date this back, probably starting with 9/11, but subsequent to that, we’ve had a whole series of events, whether it was the global financial meltdown that really took hold in just a two-week period in 2007–2008. We’ve had previous virus concerns around SARS, Ebola, H1N1. We have the European debt crisis. And in today’s globally connected economy, I think organisations are getting much better at beginning to adapt to these types of unpredictable events.
I think we’ve seen progressively, over the last few years, that companies are in a better position to react and respond to black swan events. You can’t predict when these events are going to occur; you can’t predict the pace at which they’re going to occur; and you can’t predict the magnitude that they’re going to have. But what you can do is say, “If situations occur that are going to disrupt our supply chains, or are going to have a material impact on our share price along with the rest of the market, or are potentially going to damage investor, consumer, or business confidence, what are the levers that I can begin to pull that are going to help me begin to react, to mitigate against that?” So, I think we’ve seen some of that play out.
We’re still in the relatively early days. There’s a lot more talk than there is actually real data about how severe the coronavirus is going to be. But what we are seeing is a lot of contingency plans being put into place, a lot of prevention and mitigation strategies being deployed by companies as they begin to get to the position where they can begin to flex a little bit. No one’s going to mitigate the full impact of these types of things, but those that respond with the most agility and with the most confidence are probably going to be those that weather the storm the best.
What are some of those levers that organisations can pull?
Axson: Well, I think the first thing to look at, in any type of business, is, “What is going to be the impact on my supply chain, from source to customer?” And that means having visibility and transparency to stock and inventory levels around the world, if you are a manufacturing or a product-based company. And [it means having visibility to] all the potential impact on customers if you’re more of a service-based company, like an airline or a hotel, [businesses] that are obviously being very significantly affected here. So, the first thing is to really have transparency and visibility to what’s going on where within your business.
I think the second thing is to understand what mitigation strategies you can deploy. Mitigation strategies could be things like delaying purchasing decisions, or they could be the traditional things like beginning to much more aggressively manage SG&A [selling, general, and administrative] expenses so that you’re not spending ahead of a potential downturn in revenue or sales or consumer confidence. One thing we’re seeing today is the advantage of companies having that transparency, and improving their analytic capability. So, rather than just holding onto very high stock levels in anticipation of a demand shortfall, organisations are creating more flexibility in their supply chains. Again, it’s never going to insulate you from all the effects, but it’s going to allow you to buy a little bit of time to begin to understand what the longer-term impact might be and whether you really need to make some structural changes.
Because if it’s something that’s going to impact your business for six, nine, 12 months, or, like the financial crisis, three or four years before many companies really began to turn the corner again, or whether this is just a storm in a teacup, we still don’t know.
Companies are looking to keep their options open, and visibility and transparency through information is significantly better than it was, for example, in the post-9/11 world, where we didn’t have that data, we didn’t have the connectivity, but we were still exposed to a lot of the impact of a much more integrated global economy.
There are so many aspects to dealing with the virus, from supply chain, as you mentioned, to having to close factories, market shakeups, concerns about availability of workers. Who in an organisation should be owning these concerns?
Axson: Well, it starts with the CEO. This is a CEO-level issue because the facets of the business that it impacts could be significant. Obviously, job one is worker safety. And cascading from that is things like worker availability, product availability. And then you get into some of the financial implications. Because all of those have a cash, capital, revenue, and earnings impact, but they’re really rear-end effects. The financial impact of a business event or a market event is the last thing that happens.
So, I think it’s a question of the CEO and the leadership team really beginning to understand the cause-and-effect relationships: What options do we have to begin to perhaps increase worker ability to work from home? What options do we have to begin to shift production or shift inventory around the globe so that we can begin to mitigate the impact of having products in areas where the virus is perhaps more virulent or prevalent at the moment? Again, you’re not going to mitigate all the impacts. The first thing is starting around worker safety and worker health, and then that allows you to expand from there into some of the other impacts that will occur within your business.
Enabling people to work remotely for a period of time has significantly increased even in just the last five to seven years. However, that does not work so well for a pure manufacturing operation, I think there are constraints there. Because if you’ve only got one plant making one product, and it’s in a virus-impacted zone, you’re going to have a challenge for a short period of time. We’ve already heard that from companies like Apple and others, talking about the impact on product availability. And then, perhaps the reverse situation, the ability to actually do business in markets like China or Italy, where the virus is having a significant impact on consumer behaviour.
What can companies do specifically to prepare for the idea that travel, consumer spending, and workforce availability may be diminished for a longer period of time, rather than, say, a few weeks?
Axson: That’s a fascinating question, and I think the reality is not yet clear, but I think companies have a broad range of options. It is yet another lesson for business that you shouldn’t be putting all your eggs in one basket.
Just a few years ago, I bought a new car, and its rear backup camera didn’t work. And the reason was the chip factory in Thailand that made the sensors to go into that camera had been flooded. I did some follow-up research with the manufacturer, and as a result of that one event, they actually engaged with two other backup suppliers around the world so they could begin to mitigate that impact. So, creating flexibility in your supply chain I think is a key thing. The key point here is, whether it’s coronavirus or something else, these things are going to keep happening.
Maybe it’s a global cyberattack. Maybe it’s government regulation against big technology. We’re already seeing signs of government regulation against global data powers like Google or Facebook. What will be the impact of those types of things? So, it’s important to think about how you can react and respond, what type of flexibility you need versus what type of flexibility you can afford, and make practical and wise choices against that.
Once the crisis is over, what do you think this coronavirus experience, for lack of a better term, will cause company leaders to do as it relates to advance scenario planning?
Axson: I think it will reinforce a trend that I’ve been seeing for a lot of years. The real genesis of scenario planning in business originated in the military. Scenarios were created regarding the behaviour of your enemy in a military conflict. It started in business with the 1973 oil crisis, triggering decisions on how we behave during sustained oil price volatility. Because largely, from the end of the Second World War until the mid-1970s, there had been very little volatility in the price of oil.
I think the bigger lessons from coronavirus are going to be more around areas of public health and around government preparedness to be able to react and respond to this type of event, which is essentially a noneconomic event. It’s more of a biological event.
You know, we’ve had economic events before, like the Greek debt crisis and the financial crisis of 2007–08; we’ve had military-related issues, when a war breaks out in a part of the world, you know, or a 9/11-type terrorist event. This is one of the first biological events that’s really having a seismic global impact. And we live in a world, today, where economics, biology, and technology are very intertwined with each other. So I think a lot of the lessons here are going to be taken by how did different organisations react and respond, what was their level of preparedness.
The other impact here is it’s not just large companies that are getting affected. Its impact could be on very, very small companies who are trying to sustain and grow their business in an area of the world that is affected by the virus. If you’re trying to buy an espresso in Milan at the moment, it’s probably a little challenging.
In closing, what else should organisations be asking themselves, or what else would you like to add on this topic?
Axson: I think the most interesting thing here is, what happens when it passes? Who are going to be the organisations that are best placed to take advantage of a recovery? One of the things that we found, coming out of the financial crisis, was that CFOs had done a pretty good job of creating strong balance sheets. And actually, the long-term impact of the financial crisis wasn’t as severe, outside of the financial sector, as many predicted.
A lot of this was about creating some cushion against these types of unexpected events. We’re in a situation today where, because we have sustained low interest rates, companies tend to be relatively cash-rich in their balance sheets. So one of the most interesting questions for me is, when we understand what the likely long-term implications of this event are going to be, which organisations are best positioned to respond and take advantage of any upturn.
For more news and reporting on the coronavirus and how management accountants can handle challenges related to the outbreak, visit FM’s coronavirus resources page.
— Neil Amato (Neil.Amato@aicpa-cima.com) is an FM magazine senior editor.