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Future Imperfect II: Managing Strategic Risk In the Age of Uncertainty

Part two of our series shows how utility companies can manage, but never eliminate, strategic risk.

Fortnightly Magazine - February 2007

future. They ask: How could the future diverge from the present? What are the fundamental forces driving change in the business environment and how can these forces affect the success of the business? Understanding the range of these forces and their consequences for the business leads to the central strategic question: If the future unfolds as described in the scenarios, what would we do about it?

One must begin with a strategic choice. Otherwise, the scenario process can become irrelevant to the management of strategic risk. This choice should be framed as a closed question rather than an open-ended question. For example, an open-ended question like, “How will we make money?” does not lend itself to the scenario process. In contrast, closed-end questions like those below focus the scenario process on the strategic risk being managed:

• Should we invest in developing a coal-to-liquids capability (coal company)?
• Should our next investment in base-load generation be coal fueled (electric utility)?
• Should our next commercial aircraft aim for the long-haul, large-capacity market or for the short-haul, medium capacity market (aerospace company)?

Note especially two characteristics of these questions: (a) They are framed as a strategic choice; and (b) the outcome of the decision depends on events largely outside the direct control of the company.

Identifying the Relevant Uncertainties

Next we identify the unknowns in the business environment that will exert the strongest influence on the outcome of this strategic choice over a planning horizon of about 10 years. (This period is long enough to reach comfortably beyond mere extrapolation from the present, yet not so far as to become fanciful.) These unknowns are then grouped into two principal axes of uncertainty to create a matrix for scenario building like the one illustrated in Figure 2 (see p. 32). In this example, the Electric Power Research Institute (EPRI) has identified two key uncertainties that it believes will influence the choice of generating technology: (a) the cost of venting carbon dioxide; and (b) the cost of natural gas. These can be arrayed as axes in a matrix shown in Figure 2. The horizontal axis measures the cost of carbon venting, with severe constraints on the left-hand side, and ease of emission on the right. The vertical axis measures the cost of natural gas, high at the top and low at the bottom. Each quadrant should be given a name that captures the essence of the business environment that would obtain there. This name provides a convenient shorthand for communicating the scenarios throughout the utility organization.

Writing the Scenarios

Though outside facilitators can help, each utility management must take on the task of identifying and writing its own scenarios. A high level of engagement ensures capture of the tacit knowledge in the heads of the senior leaders. In most cases, a writing team would be chosen to develop each of the four and any additional “wild-card” scenarios. In each case, the scenario should begin with a logical pathway from the current business environment to that in the scenario. In “Solid Black Gold,” for example, the