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Published on March 17, 2020
7 Tips for Defining Scenarios During a Crisis: Covid-19 edition
This article is part II in ECFO's Covid-19 crisis planning series. Our last article, "Modeling to Plan Through a Crisis: The Covid-19 edition", stressed the importance of using modeling as a tool for crisis planning. Particularly we covered both quantifying impact under different scenarios and developing mitigation measures for the short and long term under each scenario.
In our second installment, we offer a practical approach to defining different scenarios for your crisis planning, including a framework for determining the scenarios and different factors to consider when making assumptions. While we address scenario building here with the current pandemic in mind, the concepts still apply to contingency planning in general.
1. Break down your plan into distinct "Impact," "Recovery" and "Normalcy" phases
Every crisis has a life cycle. The first action to take is to frame your crisis plan by defining the different phases of the cycle. This step is essential since factors on the ground quickly shift during a crisis, and having a plan in place can shorten response times and improve mitigation efforts. Companies should approach each phase separately and define key modeling assumptions ranges (e.g., demand, inventory supply, employee participation).
One relatively versatile framework is to divide the crisis into "Impact," "Recovery," and "Normalcy." Note that areas that are not yet affected or which are expecting a second wave may also add a "Readiness" phase (before "Impact").
Impact: During "Impact," the crisis is in full display. In the case of a pandemic, this includes extremely tight public health restrictions and measures, a sharp decrease of demand, and substantial disruptions to supply chains. For China, this phase seems to be drawing to a close for most of the cities (except the epicenter of Hubei Province), as the number of confirmed cases has been continuously decreasing. For other countries, it is the beginning of this phase, and the number of confirmed cases has been increasing at a high rate (Italy announced a total lockdown as of March 10th and other countries have also followed on different levels of border control measures).
Recovery: Under the "Recovery" phase, mainstream economic activity has restarted, demand is increasing at a slow pace, and supply chains are gradually getting back on track. In many cities in China, employees have been going back to offices and even factories. A clear indication of a recovery phase is a sustained increase in demand, no matter how minor.
Normalcy: for the global market as a whole, there might not be absolute "normalcy" during a pandemic until the introduction of a vaccine. Every company needs to define what "normal" means relevant to its own business. However, this should involve a view on long-term demand, staffing, and other structural decisions.
2. Design your scenarios according to the length of each phase before proceeding to depth
To design each scenario in the model, companies should determine the duration of each phase of the cycle. Framing length of phases will simplify conversations around specific assumptions ("depth"). For a worst-case scenario, the "Impact" period would be more extended than the best-case scenario. Another important and perhaps more controllable dimension is the length of the recovery period. The table below shows a quarterly assessment over a single year, but the time period and increment will depend on the company's own perception of its industry outlook.
3. Anticipate and map demand dynamics
Companies need to asses demand realistically in each phase of the crisis and be able to quantify it. The sudden and dramatic loss of demand for goods or services is often the most significant shock to the system during a crisis. What happens in the rest of the contingency plan will be a result of this:
- Where exactly will demand come from during "Impact" and "Recovery"? Can it be influenced by discounts, different refund policies, or delivery methods?
- Has a portion of demand been lost forever? Will demand recover to the pre-crisis levels?
- Is there pent-up demand in the market representing delayed purchases (appliances, automotive, etc.)? How can a company target this pent-up demand as the economy rebounds?
- Will additional market share become available if competitors wind-up their businesses?
4. Quantify the impact of changes to employee participation
Apart from the staff that might be under government-mandated quarantine, others may be stuck in another city or needed for childcare. For manual or direct client-facing employees, performing everyday tasks may be impractical (or, in the case of a scenario in which demand has decreased substantially, unnecessary). While office workers might be able to work from home during a lockdown, the productivity of remote work is a matter of hot debate. Company culture and conditions at home almost certainly have a significant impact.
Major factors to take into account are:
- To what extent can remote work be deployed without major adjustments?
- What process improvements can be put in place to enhance the effectiveness of remote work? What are the outlays in terms of time and money?
- Is there a need to hire part-time help to make up for workers that cannot participate?
- Are there long-term process optimization or capacity-development projects that would be ideal to commence during a lockdown (employee training, rolling out of marketing content, ERP/RPA/other technology implementation)?
5. Consider the twin risks of a supply glut and undersupply
The slowdown of the manufacturing activity in China has directly affected supply chains for companies not only in China but globally. Many large companies have been able to transfer supply-side activity to South East Asia temporarily. The ability to restock or find substitutes for raw materials and consumables is critical in modeling production capacity. The share of the total amount of materials required in production that could be purchased and delivered is a useful indicator of the status of the supply chain.
Other aspects to consider:
- Assess bottlenecks in the supply chain for each phase and keep in mind that production will be restricted by the input experiencing the most profound deficit;
- Just-in-time becomes untenable and highly risky. Review "thin inventory" strategies in cases where spoilage or obsolescence is not a significant concern;
- Ask suppliers to extend terms to help finance buffer inventory.
6. Anticipate a "new normal"
It is essential to assess whether there will be a "new normal" in the given industry, especially if competitors close down or if long-term consumer behavior changes. Some of the questions that need to address:
- Can new sales channels that will be relevant to a new-normal be built-out and utilized during the "Impact" and "Recovery" phases (E.g.: restaurants modifying menus to be delivery-friendly, offering frozen food; repurposing of textile plants to sew masks)?
- What changes need to occur to support these new channels (re-tooling for factories, menu changes for restaurants)?
- What practices need to be put in place to optimize processes around these new channels (if, for example, a significant share of sales has shifted from sit-down service to delivery, then that changes the economics of operating a central kitchen compared to a full-service restaurant)?
7. Absorb and apply new information
Keep in mind that a crisis like the Covid-19 creates an extremely volatile environment, circumstances change rapidly, sometimes even daily. It is vital to update the model as many times as necessary to support effective decision making. For this reason, companies must update assumptions underlying scenarios continuously in terms of demand, supply chains, workforce, and innovation efforts.
Covid-19 has long expanded beyond a local outbreak. As of March 11th, the World Health Organization declared the coronavirus outbreak a pandemic. As Director-General Tedros Adhanom Ghebreyesus indicated, "We expect to see the number of cases, the number of deaths, and the number of affected countries climb even higher."
In addition to tracking the news, publications from consulting firms, and scholars regarding the crisis provide helpful information for developing assumptions for a model. An example of this is the white paper published by McKinsey & Company, "COVID-19: Implications for business", which outlines its own projections and scenarios.
Two weeks ago, the conversation was about how long it will take for China's supply chain to recover. Now that the virus is rapidly spreading across the world and China's economy continues to improve gradually, many are now concerned about when demand for China's goods will recover. Whether it is the current pandemic or a future event that substantively disrupts business, developing realistic scenarios upfront is essential as circumstances can change quickly.
Jenny Yip
Project Manager - ECFO Services LTD