Scenario Planning: 4 Scenarios to Evaluate Now
The pandemic in 2020 caught everyone off guard. We all hoped for a return to normalcy once vaccines began to roll out across the globe, then the Delta wave hit… then Omicron. Each cycle of optimism was met with a harsh reality of a new variant.
Every segment of the economy has been impacted, and very few could have predicted the lasting impacts correctly. In times of incredible uncertainty, many leaders use scenario planning, which provides a structured way for thinking about the future. Add in a financial model that allows you to quantify the impact of various changes— a powerful tool in your toolbox to understand a range of possible outcomes for your business— and you can begin to create strategies to mitigate risk and capitalize on the opportunities that might materialize under certain conditions.
Here are four scenarios that every finance officer should evaluate to better understand the impacts the current environment might have on your business:
Inflation and rising wages
Inflation is the word of the year so far in 2022. Is it transitory? Is it here to stay? Higher prices are leading many employees to ask for raises. Many companies have met these needs already and those that haven’t are at risk of losing their talent. How will your business respond?
- Modeling impacts to goods and services
- Define how long you think higher prices will last.
- Certain goods are impacted more than others. Can you differentiate the increases to properly account for the changes in your cost base?
- If impacts are short-term, few structural changes will be needed but likely need to build up reserves to weather the storm.
- If impacts are longer-term, what mitigation strategies do you need to adopt?
- Modeling impacts of rising wages
- Since salary increase carry-forward year over year, can you afford this structural change that will impact your budget each year?
- Many companies will lean on one-time bonuses instead of raises. While this might help your finances moving forward, is it enough to hang on to talent?
- Some will explore creative options to add to benefit packages like longer parental leave, pet insurance, and other items that employees appreciate.
- With these increases, can you still afford to hire for the new positions you hoped to add in 2022?
The Great Resignation
Despite your best efforts, it is likely you will be impacted by the great resignation. The pandemic has forced everyone to evaluate their priorities in life, and many are choosing a different path. You’ve likely experienced this already. How do you turn this into a positive?
Conduct risk assessments to identify key positions that are a risk to your business if they would resign. If only one team member knows something about a really important component of your business, could you mitigate this risk by expanding your in-house knowledge? For example, many businesses have one employee who handles the financial model that drives many of their key financial decisions. Finding a way to make this model easier to modify and share could help alleviate the hiccups that may arise if this employee decides to leave.
- Modeling impacts for staffing
- If you do have retention issues, do not jump to hire replacements for same role without first reviewing the needs of the business. It is likely that you are in a different spot than you were two years ago prior to the pandemic. Could you re-imagine the position to better fit your needs? The market has changed, so figure out appropriate costs and incorporate in your model.
- It can be tempting to hire quickly to fill open slots. However, this can lead to sub-par performance in long run, so do your best to interview a diverse set of candidates. This might create a lag and some short-term savings.
Employees have made it clear at this point that flexibility matters. Companies that hold tight to the in-office, five days per week, are at risk of losing talent. Most companies have adapted to remote setups and already made necessary investments to be functional. Now is the time to think longer-term:
What tools can you invest in to help your staff longer term? It is likely that you will need to continue to invest in collaboration tools to put your staff in position to succeed.
- Modeling impacts for remote work
- While corporate travel will likely rebound from the lows of the pandemic, it is unlikely to return in full. Companies have realized some meetings are just as effective via Zoom or Teams without the expenses and wasted productivity of traveling. If you shrink your travel budget, how else can you distribute these funds to improve customer outcomes?
- What is financial picture of closing offices? Or in hybrid setup, downsizing necessary office space? Many leaders are resistant to this idea, but money talks. You should know the financial ramifications of such a scenario before ruling it out.
Lower investment returns
Despite the pandemic, most endowments and investment portfolios have seen incredible growth over the past two years (not to mention the years leading up to the pandemic). Many professionals expect to see these returns taper off this year. Are you prepared for the impact on your budget?
- Modeling impacts for investment returns
- Many institutions that manage an endowment, rely on a spending rule that dictates how much money they can draw from the endowment on an annual basis. These rules often create a smoothing effect, to limit the short-term impact of shifts in the market. While this is great in the first year, it often creates a lagging impact where spending might be lower for two or three years after a dip in market value. Be sure to structure your model to accommodate this reality.
- Make sure you understand the impact of the spending rule will have, as well as what Board approvals are necessary if a change to policy is needed. How much flexibility do you have? How quickly can you put a change in effect?
Creating forecasts and evaluating scenarios in a financial model are not about predicting the future. As Charles Duhigg puts it:
Fortune-telling isn’t real. No one can predict tomorrow with absolute confidence. But the mistake some people make is trying to avoid making any predictions because their thirst for certainty is so strong and their fear of doubt too overwhelming… Making good decisions relies on forecasting the future, but forecasting is an imprecise, often terrifying, science because it forces us to confront how much we don’t know. The paradox of learning how to make better decisions is that it requires developing comfort with doubt.
Decision making is a skill. You can get better with practice. Creating scenarios to help you forecast “what happens if” is a great way to structure your thinking and begin to understand the ramifications of your decisions so you can begin to create contingency plans. The more scenarios you consider, the more informed and prepared you will be. Move beyond expected, best, and worst-case scenarios and uncover opportunities that will help you business succeed in any environment.