Industryweek 25114 Business Direction

Overcoming Uncertainty With the Aid of Scenario Planning

Oct. 17, 2017
Scenario planning is essentially a thorough review of "what-if" situations, with potential courses of action created for each. Preparing for various shifts in advance can prevent companies from being caught flat-footed by sudden changes.

Successful manufacturers operate from a proactive rather than reactive position. Considering the cost and consequence necessary to change even minor features of a production process, manufacturers must make a vigorous effort to stay ahead of changes.

Scenario planning is designed to give manufacturers exactly this kind of foresight. The concept is essentially a thorough review of "what-if" situations, with potential courses of action created for each. Preparing for various shifts in advance gives companies a head start on the potential outcomes. Conversely, companies that haven't properly prepared are caught flat-footed by change and ultimately compromise their competitive advantage.

Scenario planning might sound similar to a three- or five-year plan, but manufacturers should not conflate the two. Three- and five-year plans are more of a fixed bet on what the future will hold; in effect, it's the outcome of management's collective expectation for the future. But organizations that hold too steadfastly to these set-in-stone plans might not even make it to five years if they don't adapt to real circumstances. That's where scenario planning comes in — where three- or five-year plans are fixed, scenario planning is more open-ended and flexible. It considers possibilities without banking on those predictions.

As an example, consider Rolls-Royce. The automotive company realized it needed a better way to prepare for disaster after a number of factors caused its share price to plummet by 50% between 2014 and 2015. In order to do so, its mid-level and senior executives set aside a full three days for extensive scenario planning. This involved researching a range of topics that would affect the industry's next few decades, creating hypothetical future scenarios based on that research (as well as discussing those scenarios), then answering a few key questions based on their discussion that would help them develop and refine their business strategy. Rolls-Royce has noted that this practice has provided the foundation for its strategy development process for this year.

Scenario planning is important for controlling costs, avoiding disruptions, and preserving standing against competitors. Today it is even more imperative in light of tax changes, talks with NAFTA, and other factors shaping today's political landscape. Manufacturing firms need to make this a priority now.

To Be Successful, Scenario Planning Takes Commitment

Effective scenario planning requires time and resources. And while Rolls-Royce's one-time, boot-camp style endeavor helped turn its strategy around, scenario planning should ideally be a continuous effort. We recommend our clients take on scenario planning at least on a quarterly basis. A quarterly review will provide firms with enough time in between sessions to truly evaluate if the past quarter met expectations and provide updated courses of action for future scenarios.

Manufacturing companies are acutely affected by numerous changing variables, including raw material costs, employee wage and benefit costs, competitor pricing, power costs, waste disposal, etc. They also operate in low-margin environments with little room for error. So if and when a variable changes, a company can quickly find itself in the red unless it's able to react quickly.

Although each of those issues holds importance, what especially requires attention now is planning around economic policy issues. Domestic manufacturers today are faced with a uniquely dynamic political environment that could herald significant change. Whether manufacturing is overseas and the customer base is domestic or vice versa, businesses absolutely need to plan for the following scenarios:

1. Corporate Tax Reform

Under President Donald Trump, there may be major tax changes in the next year. This can include a significant reduction in the federal corporate tax rate. While the rate is currently at 35%, politicians are proposing reducing it to 20% or even 15% in the near future.

While these changes likely won’t take place until 2018 at the earliest, it’s important for companies to start planning now so these reforms won’t be a surprise. At our firm, we encourage clients to plan for a lowered U.S. corporate income tax (among other scenarios) because even if the change won’t affect client operations directly, it will certainly affect competitors and the industry — and those changes will affect our clients.

2. Border Tax

A border tax of some sort has been repeatedly proposed, but we are all in the dark as to what form it will take. Republicans have nixed the border adjustment tax, also known as a “destination-based cash flow tax,” but some other form could take its place. It is one of the few mechanisms available to directly pay for a broad lowering of the corporate income tax.

As a result, it is important for companies to consider various forms of border tax and consider how they would impact the bottom line. They should also prepare for reciprocal and potentially irrational reactions from other nations. Perhaps you are a major agricultural exporter, and the United States enacts a tariff on steel imports. A country that exports steel to the United States may put tariffs on your agricultural goods as payback to the U.S. steel tariff. A smart company will consider all the scenarios to prevent being caught off guard.

3. Repatriation Tax Holiday

A repatriation tax holiday would allow U.S. businesses holding profits overseas to bring that income home at a reduced tax rate. This is a popular concept among multinational corporations that earn income in low-tax overseas jurisdictions but then have to pay high U.S. taxes when bringing that income back.

This tax reform could be a game-changer for domestic capital investment. With an estimated $2.6 trillion currently stashed overseas, a tax holiday could unleash nearly $1 trillion in investment — particularly if the government makes the tax break contingent on companies investing the cash into infrastructure and capital equipment. Imagine if you or your competition suddenly had cash to invest in automated, advanced machinery. It would certainly upend the status quo.

Any of these scenarios could change cost margins and profitability while spurring a tremendous flow of domestic investment into machinery. And while none are likely to go into effect for at least a year or two, planning should begin immediately.

Some companies constantly ascend to the heights of the market, while others constantly fall — only 12% of Fortune 500 companies in 1955 made the list in 2016. With the luxury of hindsight, each of those companies could have changed course to preserve its growth and value over time. Instead, some force in the market overtook them, either by acquisition, merger or outright failure.

Proper scenario planning ensures that today's growing companies are prepared for any conceivable future. The smart leader will plan for all kinds of battle campaigns while knowing he or she will only have to fight through the one course or scenario that actually occurs. When the time comes, being able to pull that plan off the shelf and put it confidently into action will make the difference between sprinting ahead and stumbling.

Andrew Powch is a member of Seraph’s executive team. Seraph works with clients to transform, relocate, or restructure their business operations, and its team regularly works with lawyers as expert witnesses. Powch frequently works with leading international companies in the automotive, aerospace, energy infrastructure, and medical technology/device sectors.

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