Russia-Ukraine war: Scenario planning for an uncertain future

Speaker 1:

Hello everyone there, this is Per and am I'm happy to be here with Kevin and Tim to talk about scenario-based planning, in the context of the Russia-Ukraine war. And the reason we are so excited to talk about this is, number one, this is a big deal. This is something that will impact many of our corporate and personal lives going forward, for decades to come. Even if [00:00:30] the war ended today, this will have implications of historical proportions, so it's important to really understand how to behave and how to think about that going forward. And secondly, we've been surprised after COVID, when we speak to our clients and many corporations, that they are still stuck in the, wait and see mode. There's too much uncertainty, it's not worth planning for all the things that could, should and may not happen, and it's just hard to deal with it. And we're a little bit surprised by that [00:01:00] because, if there was ever a time in the crisis in the world where scenario-based planning should be something that everyone does, it's probably this.

And this is one of the reasons we wanted to talk about it, it's an art and a science that's been around for a long time. It doesn't solve all the problems, but it's certainly helpful for anyone who's trying to think through how to behave and how to protect their companies and their employees and their future and everything that's going on. So that's the topic of discussion, we're going to have a free-flowing discussion, talk a little bit [00:01:30] about some of the facts, and some of the frameworks, and have some recommendations at the end on what everyone can do if they want to take a step in this direction. First of all, let's talk a little bit about when and how to do scenario-based planning. When is it useful? When is it not? What is it good for? Etc. So, maybe Kevin, I'll hand it over to you. You've been doing a lot of thinking about that. When should we use scenario-based planning?

Speaker 2:

Yeah, Per, it's a great question, and I think it's something that should be done on a regular basis, not just in response [00:02:00] to a circumstance like we're facing right now. But really, you're looking at two dimensions around this. One is the degree of uncertainty in the marketplace that you're facing, and we'll talk about the variables that we're dealing with right now with the Russia-Ukraine war. But the other side of the equation, is really the management confidence that you have in the likelihood of an outcome. And when you put those together, when you start to deal with a highly uncertain circumstance where the outcome is unclear, management confidence should be relatively low because you can't predict the outcome, you're not quite [00:02:30] sure what the actions should be. This is a great time to do scenario planning. You start to model out different ways the outcomes could come about, you model out the impacts those would have on your organization, and you start to decide what you would do if indeed, that circumstance came to pass. That would be a good scenario planning situation.

There are times, however, when the circumstances will then become more clear over time, and now what was a variable before, you have more confidence and more facts around that. And this [00:03:00] is the time to shift aggressively into execution, because people who move boldly during these timeframes, who time the market right, who make the right bold calls as a leadership team, achieve that first mover advantage. So, execution and planning are kind of a nimble dance that leadership teams need to be able to do, especially in these types of circumstances. The other traps you could fall into though in this time, is being overly confident. So when leadership steps back and says, "I know what the outcome is going to be," and they start to act boldly and decisively, [00:03:30] when the reality is, they should gut check that and say, "I really can't know what this outcome is. I am making an assertion based on imperfect information," and recognize that effectively you're gambling in what the outcome could be because you should not be that confident at this moment.

Now, sometimes that gamble can pay off, and people will seem to appreciate it, and everyone will be really pleased with the outcome, but you should at least go into it recognizing that we're taking a gamble here, we're going to place a bet. Maybe it's a small bet with a big possible return, and it's the right choice for a team but you should recognize that's what you're doing. The other [00:04:00] trap is a bit more dangerous, which is purely procrastinating, which is you get stuck in the analysis paralysis, you're waiting for perfect information to come about, when it's not going to come about easily, and you're still sitting there debating the actions when your competitors are moving forward more boldly, and now you're left behind in taking those choices. So, that's kind of the balance we see for, what's the right time for scenario planning versus shifting into action.

Speaker 1:

Right. No, that's great and one of the steps we always find is that, companies struggle with, what is [00:04:30] the forecast and what's the scenario? And the good thing about forecast is, if you can forecast with some degree of accuracy, do that first, right? You don't have to build a scenario about it. So, one of the fascinating facts is that, if any company had done a strategic plan or a business plan before February 24th when the war started, chances are that several of the assumptions in that plan are already obsolete. And for that purpose, Tim, our chief economist office [00:05:00] constantly monitors the things that we can forecast, and step one is, get those things into your plan, so you don't have to do scenario planning about it and then get on with scenario planning. So Tim, what are some things, what are some directions of travel that we see for some of these key assumptions that are typically part of every business plan?

Speaker 3:

Oh, thanks Per. Hi Kevin, how're you doing? Great discussion that we have today. To use your analogy of the road travel Per, this is a rocky one from a macroeconomic [00:05:30] standpoint. I'd just like to take us back to January when we were going through the Omicron wave and looking to forecasters and saying, "Well, it looks like we may actually be finally through all the uncertainty in the last two years," and then we entered another month in the 2022 and it became clear that there was geopolitical risk, and we still see supply chain issues, and now we've got potential other headwinds coming down the pipe. And so, if you're just looking from a macroeconomic standpoint, you're asking yourself, "What has changed over the last [00:06:00] four months?" Let me throw some numbers at you.

So, at the start of the year, we're expecting growth to be above 3% GDP growth. The first quarter contracted by 1.4%. Now we expected a soft first quarter, but not necessarily that soft. There's some silver lining there I'll talk about. If you move on to inflation, economists probably should never be allowed to use the word transitory again, because we've been saying inflation's going to be transitory and transitory and transitory, but it remains high. The latest reading was 8.3%, that's [00:06:30] down from 8.5 in March. So, you've got a little bit of a slide down but still not much. My historical standard is quite a bit. We are now forecasting that inflation will be above 6% at year-end. That's a percentage point and a half, above where we were in January. Just going down the list, what does that mean for the FED? Right? Well, higher inflation means more interest rate increases. We're now looking at a federal fund rate that could hit two and half percent by September, potentially. That is a full [00:07:00] almost, percent and a half above where we thought we were going to be in January.

So, some very aggressive movement here by the policy makers to get in front of this inflation. And I want to step back even for a second and talk about, what this means from a macroeconomic forecasting perspective. And so, Perry and Kevin, you mentioned getting the point estimate right, we're always trying to do that in macro, right? And we struggle to get even the next quarter, the next month number. That's an undertaking to use a baseball analogy. [00:07:30] If you're batting 300, you're doing quite well. But that's not the world we find ourselves in at the moment. I'd say batting 200 in this current environment with all the uncertainty that we're facing, with all of the headwinds that we're facing, that would be a pretty good batting average.

And so, why it's that, is because if we're talking about scenario planning, you want to think about not just where the point estimate is, but what those error bands are around your estimate, and those error bands have blown out. To Kevin's point, you're just thinking through, "Okay, what's scenario A, B and C, [00:08:00] what if inflation is at eight and a half? What if it's at six? What if it's at two?" Right? All of those are possible outcomes and the distribution of those outcomes is actually flatter than it used to be, because we're not entirely sure where it's going to end up. And so, in that world as a macroeconomic forecaster, you want to be conscientious of the models you're using and how GDP interplays with rates, interplays with the possibility of a recession, because all of those things matter when you're thinking about those connections, matter [00:08:30] when you're thinking about going to different states of the world.

Speaker 1:

Absolutely, and that's hard enough, right? But I mean, you can use a number of these forecasts, you can use hours that are available, you can do averages of a number of different players, if you want to be more or less optimistic or pessimistic, but once that is out of the way, let's say I've updated my business by my strategic plan, I've taken GDP, inflation, all that stuff, whatever is most important to me to account, then we start a scenario planning, right? Step one is figuring out, [00:09:00] what are the vectors of uncertainty? And in the ideal world, in the simplest world, you only want one. Unfortunately, this world is very complex, this conflict is very complex, right?

So, you can't just pick one vector and in this case, we are thinking about the military side, we're thinking about the cyber, the economic impact, all these different things. And it's a vector because it has a milder and a more severe impact. Think of it as, stops along the subway station map, right? You can start and get off [00:09:30] at any of these stops and you're in a different world. Kevin, take us through, how did we land on these five vectors of uncertainty and some of the steps along the way?

Speaker 2:

Yeah, Perry, I think, as consultants, we love everything to fit into a nice neat two by two, but the reality is, you've got to deal with more complexity as you're talking about, especially, in the circumstances we find ourselves in now, which brings into the equation of military conflict that we've not really had in most of the world for quite some time. So, these are new variables that people [00:10:00] are having to contend with. So, trying to scope this down into something that is both manageable and relevant to a leadership decision making process is what you have to do. So we settled on five variables this time. One is around the military conflict itself, the kind of impetus for a lot of these other changes is being driven by this. And there's a degree and a spectrum of what could emerge in this as we all read about daily, it continues to evolve, but you can imagine it staying just within the scope of Ukraine.

So, that's where the Russian [00:10:30] invasion is contained, Russia doesn't escalate, it doesn't scale beyond the borders of Ukraine. You could envision it crossing those borders and stepping into areas in neighboring countries, broader parts of Western Europe could be involved in that, whether they are drawn into it because of actions that Russia takes, they feel compelled to act, or Russia is actually provocative and acts outside the Ukraine border, and now all of a sudden you've got Europe at scale. Then the other equation is, you start [00:11:00] to move into other parts of the world. You've got Russia and China having conversations about, what are they doing in this collaboration going forward? Would China choose to take an action against say, Taiwan, during this time while there's a lot of focus on the Ukraine situation? Does China take advantage of that? Now all of a sudden, Asia is in play also in a military conflict situation.

And then lastly, does that draw the rest of the world into that conflict? So you have to think about the escalation path there and some of the trigger events. There's been a lot of talk [00:11:30] about whether nuclear weapons would be on the table. You can imagine the use of one, even in the Ukraine confines, would compel other countries to act and respond, so that would escalate relatively quickly. On the economic front, that's another part of this ward. There's obviously been parts of prior wards as well, but it's very acute here given the new global nature and their interdependencies within the economy. So, we began with a lot of sanctions against Russia, but we kind of drew the line on energy [00:12:00] because of the interdependencies and the challenges that would face for other economies.

But now, all of a sudden we're seeing energy become weaponized from Russia, forcing it to be a way to prop up the [inaudible 00:12:12], and also European nations cutting off their demand of Russia to further cripple their supply of funds coming in. So, energy is becoming a weapon in this new economic war. You start to think then a little bit further about other sanctions that may need to come into play, and these are again interrelated. [00:12:30] So if, for example, China and Russia started to act more in alignment around this action, would there be sanctions against China and the economic ripple effects of that? And then lastly, you get into a true global trade war, where these things escalate to the point where every nation is in an economic battle.

We mentioned cyber pair. I think this is a dimension we haven't necessarily seen in traditional warfare before, because it's a new dimension, but it's one we can't ignore one. One, you start with misinformation at scale. We've always had propaganda, but now [00:13:00] we have propaganda that can reach millions in seconds. So how does that start to play out? You start to think about the ability to control communications channels and whether those can be turned off or turned on. How does outside certain borders get access to new information? That's a challenge. Our interconnected financial systems could be a point of exposure. Is there a disruption or a challenge caused by a cyber attack in the financial systems, and what would that then do to the economic circumstances?

And then lastly, you have so much of our infrastructure that is tied to a [00:13:30] cyber network. What would happen if suddenly Russia reached out beyond the borders of Europe even, and started shutting off major infrastructure systems in countries they see as enemies in this battle, for example, water shutdowns in New York city or a power shutdown in San Francisco? What would the nature of that effect be? A couple of others I think, that you have to factor in that are not necessarily impetuses but more byproducts, one is the civilian effect of this. Right now, we're seeing massive numbers of refugees leaving Ukraine [00:14:00] for parts within Europe. And so far, there's been a very welcoming, receptive environment, lots of support and outpouring to support the refugees that are coming in. But if this war were to continue to escalate and move beyond Ukraine, would that create a crippling effect of refugees?

Now, instead of 8 to 10 million people, we might be looking at 10, 20, 30 million displaced people, and where do they get housed going forward? You start to expand beyond that, to think about other civilian populations that could be hurt by an infrastructure [00:14:30] attack on the cyber side, or even at risk populations that are already struggling with the food shortages being created by the crisis. So, at risk populations in far flown parts of the world, very disconnected from the current conflict, are starting to feel the shortages because of the production that's not reaching them, from Russia and Ukraine going forward. So, we have to start to think about the civilian effectiveness.

And then lastly, as a leadership team, you have to factor in the time equation. This is a very unpredictable time horizon. We could be done with this within [00:15:00] less than a year, Russia could pull back, there could be a settlement, we're not sure what it might be but it could be over and we could move past it. This might be a very long prolonged occupation, and is again limited to Ukraine or expanding across Europe, over a one to three year time horizon. How resilient is your supply chain? How resilient is your economic footprint, if you had to endure the current environment for an extended period or even longer? What if this went on and scaled out for three plus years? Now you have to start to bring in additional variables into your planning. [00:15:30] So those are the different dimensions. You have to start to think about each of those spectrums as you're moving forward because you don't control any of them. You have to respond and react as they evolve, and they're going to evolve on different horizons.

Speaker 1:

No, I fully agree, and this is what some people find hard, right? I mean, every single thing you said is kind of scary and not good, right? And human behavior of course, is to, no one talks about it or have to deal with the implications. So, one of the values here is just, kind of calling it out as options, right? And none of this is [00:16:00] a prediction. We are not predicting, nobody can, which stop along that subway line? That will happen. But they are possible outcomes with very different probabilities.

So, once we have those five, and there is only three, four options on each one of those. So, theoretically, you have five to the power of three or four combinations. That's obviously not practical for a management team to deal with, right? So, step two then is, take those five and [00:16:30] put together a menu, think of them as Chinese menus, right? Or you take different components, and make a scenario that paints a different corner of the canvas of history, and pull that to one extreme, and then you can kind of deal with it and see what comes out in terms of your sensitivities. So Kevin, you have worked on prepackaging, a couple of these scenarios. Maybe just hit on a few then. Obviously, every company needs to do their own and make their own mix here [00:17:00] but, give some examples of some ways to put together these five ingredients to something that we can talk about as a leadership team.

Speaker 2:

Yeah. I think that point you made there is, companies do need to consider what's most relevant and practical for their planning exercises and draw the line and a reasonableness test that says, "Are we learning something from going through this exercise, or does it just feel like we're repeating ourselves?" And some of the ways to do that, is to think about the polarizing components of it. Right? So, on the smallest scale, we would have essentially [00:17:30] a Ukraine invasion scenario, where it is short duration, limited military conflict to Ukraine, it is over relatively shortly, it does not escalate from an economic or a cyber path along this way, and you had to say, it's the best possible outcome when you're dealing with such a travesty that's going on right now, but it could be over and done on the smallest scale possible.

So, that is one scenario that's worth modeling out, and what would you do as a decision making [00:18:00] team around that? On the far extreme end, you'd have, Pre-World War III, right? So, all of a sudden it escalates on literally every front, the weapons used draw more organizations in, Russia scales beyond Ukraine, NATO gets involved, now of a sudden, you have an escalation. You hesitate to say how to model that out because, it's almost an all bets off, kind of scenario because the whole world's attention is going to be on that conflict at that stage. But it is worth considering as a polar opposite to that. And [00:18:30] then you have some of the scenarios in the middle. One is, doesn't escalate purely on a cyber basis. Right? So, this is a very realistic option where the military conflict on the ground remains in a relatively narrow physical footprint, but the outreach from a cyber attack's standpoint escalates more dramatically. This could occur because Russia feels greater economic pinch. They might use some of the cyber as a way to grant some of their economic sanctions away.

So, those are ways to [00:19:00] think about that. So, what would happen and what exposures do you have or how likely a target is your organization to some of that cyber escalation as a possible scenario? The other would be escalation of the economic scenarios. So we talked about whether additional international sanctions would be required. It's probably worth modeling that out, because the challenges we've all had with supply chains through COVID, have escalated now in certain domains because of this conflict, but that would scale even more broadly if the international sanctions became more widespread than limited to just Russia. [00:19:30] So modeling out the likelihood of which countries might be involved, what your exposure is within those countries, both from a revenue and supply chain's standpoint, and what your mitigation options might be, should you find yourselves embroiled in that circumstance?

And then lastly, is to think a little bit beyond just the current impetus around Russia-Ukraine and say, "What if there was a unilateral action taken by another country, like in Asia, for example, and start to think about what would that do, even if it was independent of the current actions, [00:20:00] because you want to refresh your models as new information comes on board, and be prepared for things, not just in the here and now, but things that might occur because there's no regulation that says, if China wanted to take an action against Taiwan, they need to wait for Russia to be done with Ukraine. So, there's no requirement that there's a sequence here. You have to be prepared for an eventuality. Again, don't spend hundreds of hours on it, but just know what you would do in case that action started to take place.

Speaker 1:

Right. And again, now it gets even [00:20:30] scarier when you put that all together. Right? And so far, it's been focused on the outside world. So, now come step three, right? Let's get really practical and specific to your own company. So how do you do this? We have many different ways, but one way is just, have the team prepare some of these scenarios, get in the room and get a cross functional team, the whole leadership group, somebody from strategy, somebody from finance, HR, supply chain, all aspects of your operations. [00:21:00] If you have multi geographies, please have people from any geographies and play up one scenario. Why not start with the scenario that all the really terrible, is the least severe and say, "Okay, let's think about what if this scenario became reality over the next 3, 6, 12, 18 months? What would be different for a company than it is today?

And then have each person comment on that. Well, for strategy, it would mean that we have to reprioritize our supply chain [00:21:30] strategy, right? We have to go to different countries, etc. For finance, it means that we have to deal with a certain higher degree of inflation and the cost of our capital will change, etc. And then, start to have it moderated in the room that kind of takes down the comments, challenges a little bit back and forth. Take a break, come back and then take another scenario, and each scenario becomes increasingly more severe, and have the same [00:22:00] person comment on the aspects of what the impact would be, both for their part of the company and for the company as a whole. And by the end of that day, when you've gone through all the scenarios, some of the key conclusions emerge part of the company is going to be harder hit than some other parts, right?

Some scenarios are really more sensitive for your particular company than others. You need to take care about the underlying drivers of those, right? There's going to be debate in the room, people [00:22:30] will disagree about some of the impact on the likelihood of these scenarios. Those are great because that means that there's value of determining whether it's left or right, right? Launch more analysis, do some more facts, do some more detail scenario planning to play out which one of those is most likely. And then, take back the key [inaudible 00:22:50] end up with 5, 10 key uncertainties, key sensitivities, and prioritize them on likelihood and potential impact on the company. Those become [00:23:00] your planning actions, right? And divide it up and go deeper, get more facts, monitor more closely, etc. And just by doing that, the mindset and the awareness and the preparations for taking decisions quicker, have already been achieved, and the more you learn and the more detailed you prepare, the better it can all be.

So that's kind of, step three of the process if you will. So Kevin, think through, if we are now a random company here in the world and we are interested in this, [00:23:30] depending on how urgent you feel it is, etc, what are some next steps that every company should think about doing, no matter how severe you think the impact will be for you or your customers or your partners?

Speaker 2:

No, I think the exercise you laid out is a great next step. The one thing that comes out of that exercise then is a set of potential mitigation actions that if this scenario emerged, what would we want to do in response to that, and what you need to qualify those mitigation actions on is, [00:24:00] how long would it take to enact that change? Right? So, something as that could be done within a day or two. If you have the flexibility to do that, that's great. We don't need to invest a lot in maintaining that option because we can make a pivot relatively quickly and offset this exposure. If the offset is going to take itself several months to implement, the question is, is there a prudent choice you should be making to build up a, what if, scenario plan, but also start to take some of those preliminary actions? If diversifying [00:24:30] your supply chain, for example, is something you believe is a great mitigator for several different scenarios on the horizon, that's a multi-year kind of discussion where you need, new suppliers, new partners, new distribution channels, etc.

So, that's not something you're going to change overnight. It might be prudent even though there's a short term cost to do so, you may move to a new diversified supplier base over the next couple of years, to give yourself more options down the road, should a scenario emerge that causes your supply chain to be challenged. So understand the time horizon [00:25:00] of the response will dictate some of the action you should start to take sooner rather than later, and then no regret space.

Speaker 1:

Absolutely. So, five key things to take away. Number one, you've got to recalibrate your forecast. That's the easy part, you've got to do it and keep doing it as more data comes in. Tim and his team is looking at this, on a regular basis [inaudible 00:25:24]. You've got to do that, that's basic. Number two, start the scenario planning process, start thinking about the vector's uncertainty, [00:25:30] put together a few of those and be ready for a discussion. Number three, get the team together, get the cross-functional leadership team together, maybe at the top level, maybe at the parts of the company that's going to be... And have some version of that dialogue, right? And then, take the industry and function specific. Every company will not be impacted the same, different industries will be seeing quite different impact and every function within every company.

Every company will have a unique footprint if you will, right? So, draw those implications [00:26:00] and then go finally develop the contingency plans. No matter how unlikely, by putting some energy into that, you are much more likely to be able to take quick decisions and not be left behind when the world starts going, if you will, at that pace. So, it's easy to say, hard to do in reality, nobody can claim to have the crystal ball here. And it's not about having crystal ball, it's just, don't wait and see, when there are things you can do now that can materially [00:26:30] impact your ability to safeguard your company, your people, and contribute, to minimize the impact of this entire crisis on the economic world. Thank you very much, Kevin, Tim, that's a wrap.

Speaker 2:

Great seeing you guys.

Speaker 3:

Great. Have a good weekend.

Speaker 1:

So, is that it? What do we do?

Speaker 4:

I think I might have stepped on everybody's audio there at the very end. I was going to make [00:27:00] a comment. Perry, if you can just do that out bit, one more time. I'd like to thank Tim and Kevin for being with us today and just a little sign off. I would say with,

Speaker 2:

Just don't say, have a good weekend, because this isn't happening on a Friday, right?

Speaker 4:

You read my mind. I was just about to... So, I'll go on mute and [inaudible 00:27:24], if you just want to give us one more out, I'll be quiet.

Speaker 1:

[00:27:30] Okay. And with that, I just want to say thank you Kevin, thank you Tim, for getting on and talking about it, thank you for co-authoring the white paper with me. And for everyone out there, if you have any questions, any suggestions, ideas, or just want to have a dialogue about any of this, you're more than happy to reach out and pick up the phone or send an email and we'll be in touch.

Speaker 2:

Thanks guys.

Speaker 3:

Thank you.

Speaker 4:

[00:28:00] All right.