Improved Leadership. Competitive Advantage.

Over the last 6 months, we’ve borne witness to one of the most precipitous drops in the world’s core commodity—oil. At the time of this draft, a barrel of crude is off 45% from its 2014 high. Applying the rear-view mirror technique, the arithmetic seems rather straightforward. The U.S. shale boom is putting millions of barrels of supply into a global economy that is slowing. Prices were bound to drop.

What is particularly surprising to us is the sheer number of leaders and investors who were caught flat-footed by the plunge. There is a lesson to be learned here, though, and that’s the importance of scenario planning. Those that accounted for Brent Crude at $50 a barrel will survive; those that didn’t and borrowed heavily assuming $95 per barrel of crude are in jeopardy. As the initial draft of this newsletter is being handcrafted in an airport, we couldn’t help but acknowledge that the airline industry may just be best-in-class when it comes to scenario planning—both on tactical levels (e.g., geese fly into an engine) and strategic levels (e.g., adjusting to swings in jet fuel prices).

Here are 4 points to consider regarding scenario planning:

First, devote time. At least once per quarter, leadership should mandate time to engage in scenario planning exercises. These exercises don’t need to last long—90 minutes or fewer is fine. However, it is important to cordon off time on the calendar and to do it quarterly. The reason is that the world changes rapidly, and doing scenario planning once or twice each year is hardly enough given the amount of environmental turbulence and change.

Second, imagine the unimaginable. Once we program the time, we must allow the brainstorming to be unprogrammed and unstructured. This means drastically challenging assumptions and the rate and direction of trends. Read Michael Lewis’s The Great Short in which he details the story of an unheralded money manager, John Paulson, who made billions by conducting a variant of scenario planning. He simply challenged the assumption that home prices don’t always go up; they can also go down. Until then, the dominant logic was that homes always appreciate in value. He shorted the U.S. housing market while everyone else was piling in, bidding prices up. He made billions. While everyone now is asking, “What about oil at $35 a barrel?” who is asking, “What if oil returns to $105 a barrel?”

Third, write your thoughts down—even if it is only on one page. Talking about differing scenarios is fun, but talk can be forgotten—the written word, less so. Simply, jot your thoughts down and draft up an executive summary of no more than 2-3 pages of how you and your team would react to some differing scenarios. At a minimum, you should have three options to discuss: 1) things get better for our business, 2) things get worse for our business, and 3) things stay the same for our business. When things get antsy, you can always go back to the written document when cooler heads were discussing the possibility of different events.

Lastly, engage some close stakeholders, such as your Board of Directors, in this scenario planning process. Not only are you keeping them informed, they can also provide nuance and a healthy challenge to your perspective.

The reason why we don’t naturally gravitate toward scenario planning, very plainly, is that we are afraid to purposefully imagine a place or an event that could cause harm or threaten our survival. It is much, much easier to assume that the current trend line will continue. This mental safety is an illusion. World events (i.e., Ebola) and industry disruptors (i.e., Apple’s iPhone) change the calculus of the game. Scenario planning provides a head start, sometimes just seconds, to prepare. This preparation can be the difference between survival and demise. So, go ahead, and change your oil. If you need someone to help with the scenario planning, we can facilitate that here at ELP. Give us a call today.