COVID-19: Board oversight of scenario planning

Tuesday, 26 May 2020

Javier Dopico GAICD photo
Javier Dopico GAICD
Senior Publisher, Australian Institute of Company Directors

    The COVID-19 pandemic and economic crisis is tasking boards with stabilising their organisation and pivoting towards a viable ‘new normal’. The challenge is that they need to do so in a complex environment with few certainties about what is yet to come.

    As organisations adjust to the post-hibernation environment, they need to consider a variety of potential rebuild scenarios and use them to develop an agile plan of action. The best way boards can support management plans to restart their organisation is ensure that the rebuild strategy is revisited regularly and that it is assessed in the various best-to-worst-case scenarios.

    What are we seeing in the past four weeks of the COVID-19 environment?

    Matt Fehon, Partner at McGrathNicol Advisory, a member of Turnaround Management Association Australia (TMAA), explains the initial stages of shock recovery and survival mode – where organisations looked internally at how staff and the business needed to manage the disruption – have begun to make way for the wave of first movers. These first movers are now looking at the external environment and identifying business opportunities for a broad reboot to their organisation.

    The external environment is challenging with low business and consumer confidence, contracting business activity, a protectionist global outlook and domestic unemployment forecast to reach ten per cent. Social distancing appears to be here to stay for the foreseeable future and its impact on productivity is as yet unknown.

    What could national recovery look like?

    “There are three potential national recovery models and organisations should be planning for all”, explains Fehon. A V-shaped recovery is the least likely at a national level, but it may occur at an industry level and will depend on the impact of government stimulus policies:

    • V-shaped (steep decline and steep recovery):
      - Key considerations for this recovery include efficient access to key suppliers and ensuring compliance with a changing/complicated regulatory environment.
      - Strategic considerations include how to remobilise effectively, how to onshore or diversify to viable key suppliers, and how to identify M&A opportunities and execute quickly.
    • U-shaped (lag between decline and recovery):
      - Key considerations include changes in consumer confidence/behaviour and identifying optimum operating levels.
      - Strategic considerations include how to diversify into new markets, how to accelerate the shift to e-commerce/ digitisation, and how to access new sources of capital.
    • W-shaped (slow and staggered recovery):
      - Key considerations include changes in consumer confidence/behaviour and navigating unknown supply and demand forecasts.
      - Strategic considerations include how to diversify product range and offerings, also how to accelerate the shift to e-commerce/ digitisation, and how to prepare for a second, third, etc. downturn.

    Key considerations for developing a recovery strategy

    Mathew Caddy, Partner at McGrathNicol Restructuring, also a member of TMAA, says boards need to visualise what stability – the new normal – will look like for their organisations as they exit crisis hibernation. This visualisation allows for a range of recovery strategies to be considered and pressure tested. At a macro level there’s likely to be one eventual national scenario but it’s probable for there to be several scenario considerations that play out at industry micro levels such as customer, supplier and competitor.

    The most effective approach for directors in leading their organisation’s recovery strategy is to anchor the following key considerations:

    • What is our current strategy?
    • Where do we stand today? There needs to be a frank assessment of where the organisation was pre-COVID-19 and where it is now.
    • What are the implications for the new normal? The answer will have layers depending on the organisation’s diversification and existing culture and capacity to sense and respond to risk and opportunity.
    • Where might we be headed? The answer will need to align to the organisation’s vision and mission and values.
    • What scenarios have we considered? Examples of how various scenarios may be presented include different percentages of recovery of revenue, different time periods in terms of economic conditions, and the worst-case scenario. The quality and timeliness of information provided to the board is always important but in terms of pressure testing recovery strategies it becomes critical. Recovery scenarios need to consider:
      - probable changes in customer behaviour;
      - supply chain risks;
      - working capital impacts of the hibernation;
      - cost base in light of different demand models (this depends on the speed of recovery);
      - capital expenditure and investment; and
      - funding (the working capital required to restructure).

    Scenarios need to be flexible as one of the aims of organisational strategy is to manage uncertainty. As recovery is unlikely to be a straight line, it is important that each recovery strategy that is being considered enables the organisation to operate under the following three recovery principles:

    1. Preserve cash.
    2. Identify levers to expand or contract.
    3. Establish clear thresholds in order to monitor and respond – for example, when revenue drops below, or the cost base increases above, the new forecast.

    Scenarios also need to look at external factors affecting suppliers, customers and competitors, and stakeholder questions to be asked include:

    • Where are we in terms of impact to our industry?
    • What challenges do our customers and suppliers face?
    • How long is their recovery?
    • How are our competitors responding?
    • What are the industry risks and opportunities?
    • How is our pre-COVID-19 strategy affected?

    The importance of robust financial forecasting

    Caddy emphasises the importance of getting financial forecasting as robust as possible for effective scenario planning. “There is a critical need to understand cash flow post hibernation”, he says, “as liquidity can pivot very quickly.” He goes on to explain that it’s more important to be on top of cash than earnings in recovery for three reasons: assessing revenue post-hibernation will be challenging; payment deferrals start expiring; and an increase in costs associated with rebuilding may result in short term liquidity issues.

    The AICD has published a useful director tool for managing cash flow during crisis for SMEs and NFPs.

    Assessing investment or acquisition restructuring opportunities

    Mergers and acquisitions are difficult to get right at the best of times. When such a restructure becomes necessary, scenario planning becomes critical so that short term goals don’t overtake the longer-term future of the organisation.

    The logical place to start, says Caddy, is with a frank assessment of the pre-COVID-19 business. “Good times paper over organisational cracks, however bad times [put a] spotlight on poor performance.” Opportunities need to be considered for restructure, and options – based on what has changed and what must change – include changes to:

    • Divisions or subsidiaries (divest poor performance and ensure what remains aligns to vision/mission)
    • Products and services offered (look at profitability and efficiencies)
    • Overheads and headcount (start at the highest cost outflows)
    • Customers and suppliers (look at customer demand drivers and make sure there is diversification in the supplier base)
    • Channels to market (pivot to current COVID-19 online and national environments)

    Boards should satisfy themselves that management has thoroughly considered whether the organisation needs to restructure in order to survive and thrive. Equally, they should also be asking whether the organisation is a takeover target or whether it should be in acquisition mode (for example, is now the time to take on a flailing competitor and improve efficiencies?)

    Finally, all restructuring scenarios need to get their capital structure right and test questions should include:

    • How much do we need via each scenario?
    • What options are available, in terms of debt, equity and alternative lenders?
    • Are we able to act quickly? Debt and equity providers are happy to talk at the moment.
    • How do we secure funding? Make it easy for lenders, with a credible strategy and robust financial forecasts.

    Effective oversight of COVID-19 scenario plans

    Although most leadership teams are unable to predict the full impact the COVID-19 pandemic will have on their organisation, scenario planning will help contain the uncertainty. Boards should support management in understanding the various drivers and outcomes in order to maximise their organisation’s capacity to recover and rebuild by:

    • Establishing a cross functional project team – separate to the crisis management team – to develop and oversee the implementation of defensive bookend strategies, including best case scenario and further disaster recovery scenarios.
    • Planning and forecasting for the stable ‘new normal’.
    • Completing a comprehensive base case risk and exposure assessment, addressing all potential financial, operational and regulatory governance related risks.
    • Sourcing reliable and up-to-date industry and environmental information, free of political, economic and media positioning.
    • Updating financial forecasts and related operational planning for conservative base case and downside scenarios (including worst case).
    • Considering potential acquisitions, restructures and divestments.

    To hear the COVID-19: Scenario Planning - Financial, hibernation and rebuilding strategies webinar in full please download the recording here.

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