Models of Scenario Building and Planning

Bocconi on Management Series

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Vittorio CodaENTREPRENEURIAL VALUES AND STRATEGIC MANAGEMENTEssays in Management Theory

Guido Corbetta and Carlo SalvatoSTRATEGIES FOR LONGEVITY IN FAMILY FIRMSA European Perspective

Antonio MartelliMODELS OF SCENARIO BUILDING AND PLANNINGFacing Uncertainty and Complexity

Enrico Valdani and Alessandro ArboreCOMPETITIVE STRATEGIESManaging the Present, Imagining the Future

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Models of Scenario Building and Planning Facing Uncertainty and Complexity

Antonio Martelli Bocconi University, Milan, Italy

© Antonio Martelli 2014 Foreword © Robert M. Grant 2014

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Library of Congress Cataloging-in-Publication Data

Martelli, Antonio. Models of scenario building and planning : facing uncertainty and

complexity / Antonio Martelli. pages cm.—(Bocconi on management)

1. Strategic planning. 2. Decision making. 3. Industrial management. I. Title.

HD30.28.M3656 2014658.49012—dc23 2014024352

Softcover reprint of the hardcover 1st edition 2014

ISBN 978-1-349-45119-7 ISBN 978-1-137-29350-3 (eBook)DOI 10.1007/978-1-137-29350-3

Probable impossibilities are preferable to improbable possibilities. Aristotle, The Poetics

vii

Contents

List of Figures xii

List of Tables xiv

Foreword Robert M. Grant xv

Preface and Acknowledgements xvii

List of Abbreviations xxi

1 Why Scenario Planning? 1 1.1 Events, change and trends 1 1.2 Uncertainty … 3 1.3 … And complexity 6

2 The Missions of Scenarios 13 2.1 Single-point and multiple perspectives 13 2.1.1 A tale of two cities 13 2.1.2 Looking beyond the words 15 2.2 A brief history of the scenario approach 20 2.3 The multiple perspective 24 2.4 Scenarios and their missions 26 2.4.1 The first mission of scenarios: replacing linear,

single-point predictions 26 2.4.2 The second mission of scenarios: to reduce

uncertainty and to anticipate complexity 29 2.5 Scenarios: the state of the art 32 2.6 How and when are scenarios useful? 35 2.7 The Shell scenarios 37 2.8 Recapitulation: in search of a theoretical

foundation for SBP 38 2.9 Terminology 39

3 The Fundamentals of Environmental Analysis 40 3.1 Research as the foundation of scenario building 40 3.2 The environment as a conceptual framework 42 3.3 Analysing the environment: the internal environment 44 3.4 Analysing the environment: the external environment 50

viii Contents

3.4.1 The microdimension 50 3.4.2 The macrodimension 62

4 Information, Intelligence and Competitive Intelligence 71 4.1 What is intelligence? 71 4.2 Economic, business and competitive intelligence 73 4.2.1 “Competitors” learning in a war context:

Harry Hinsley and British Intelligence in the Second World War 75

4.3 Intelligence and signals 76 4.3.1 Strong signals 76 4.3.2 Weak signals 78 4.3.3 Weak signals and intelligence 79 4.4 The case for competitive intelligence 82 4.4.1 Competitive intelligence and the levels of

uncertainty 82 4.4.2 Competitive intelligence and the spheres of

influence 84 4.4.3 A framework for the analysis of competitive

intelligence 85 4.4.4 Early warning 87 4.5 The competitive intelligence cycle 91 4.6 The competitive fog 93 4.7 A final note: information orientation 95

5 The Principles of Scenario Building 97 5.1 After the research is done 97 5.2 Formalised or nonformalised approaches? 100 5.3 The procedure 100 5.3.1 The first step: singling out the fundamental

system drivers, or the search for causes 100 5.3.2 The second step: the search for effects 105 5.3.3 The third step: defining the time horizon 107 5.3.4 The fourth step: assembling the expected

trends and events 113 5.3.5 The fifth step: configuring the scenarios 115 5.3.6 The sixth step: drawing the conclusions 117 5.4 Building a scenario: the energy 2005–30 case 117 5.4.1 The assumptions 117 5.4.2 The methodology 117 5.5 Conclusion: a comparison between the two scenarios 123

Contents ix

6 From Scenario Building to Scenario Planning: Intuitive Logic and Trend Impact Analysis 124

6.1 Models in scenario building 124 6.2 The approach based on intuitive logic 125 6.3 The case of the European steel industry (2007) 125 6.3.1 The environmental analysis 125 6.3.2 Aims and method used in the scenario analysis 128 6.3.3 The baseline projection 129 6.3.4 The FSD 130 6.3.5 The scenarios for 2012 135 6.3.6 Some final considerations 139 6.3.7 Looking backwards from 2013 140 6.4 The approach based on trend impact analysis (TIA) 141 6.4.1 A first “naïf” model 141 6.4.2 The canonical TIA model 143 6.5 The man-made fibres case 147 6.5.1 The environmental analysis and the

baseline projection 147 6.5.2 The building of man-made fibres scenarios by TIA 149 6.5.3 The configuration of the scenarios 151 6.5.4 The scenarios 152 6.5.5 Policy recommendations 154

7 From Scenario Building to Scenario Planning: Cross-Impact Analysis and Morphological Analysis 157

7.1 The approach based on cross-impact analysis 157 7.1.1 Origins of the method 157 7.1.2 Who will win the championship? 158 7.2 Further developments in CIA 160 7.3 The Galba case 161 7.3.1 The environmental analysis (2001) 161 7.3.2 The building of scenarios for Galba by

means of (verbal) CIA 163 7.3.3 The impact matrices 164 7.4 The morphological approach 168 7.5 The European Space Agency case 171 7.5.1 Environmental analysis and methodology 171 7.5.2 The scenarios 172 7.5.3 Implications of the scenarios for the

European space sector 173 7.6 How to use a method 176

x Contents

7.7 How to choose a method 179

8 Scenario Planning, Strategies and Mental Models 181 8.1 Scenarios and strategies: a complex relationship 181 8.2 The link 184 8.3 Beyond the mental models: the role of creativity 190 8.4 Mental models and distributive coalitions 193 8.5 From scenario planning to strategies … and backwards 196 8.5.1 When is a scenario successful? 197 8.5.2 Past successes and failures of strategies 198 8.6 The learning organisation 199

9 Scenarios in Decision-Making 202 9.1 The problem 202 9.2 Decision-making: a glimpse into the state of the art 202 9.3 Intuition and rationality in decision-making theory 204 9.4 Uncertainty and risk in decision-making 207 9.4.1 The theoretical perspective 207 9.4.2 The framing effect 208 9.4.3 Neuroeconomics 211 9.5 Connecting decision-making with scenarios 211 9.6 The strategic decision-making process in the

scenario-approach framework 212 9.6.1 The problem 212 9.6.2 An interdisciplinary frame of mind 213 9.6.3 An orientation to integration 213 9.6.4 Information 214 9.6.5 Uncertainty 215 9.6.6 Interconnection with actions 215 9.7 Scenarios and risk assessment 216 9.8 Time and common knowledge 218 9.9 Three final focal points 219 9.9.1 Making decision-making more flexible 219 9.9.2 A reflection on the use of history 219 9.9.3 Visions 220

10 Scenarios and the Organisation 224 10.1 The “who” question 224 10.1.1 Which scenarios? 224 10.1.2 Structure and functioning of the scenario teams 225 10.2 On the role of external experts 226 10.2.1 Cosmopolitans and locals 226 10.2.2 What to expect from them 227

Contents xi

10.3 The strategic conversation 230 10.4 Scenarios and the learning organisation 231 10.5 Why scenario building and planning is here to stay 233

Appendix A The Most Important Present Trends in the Globalised World 236

Appendix B A Reminder of Probability Theory for Scenario Applications 254

Notes 274

References 276

Index 285

xii

List of Figures

If not otherwise indicated, the figures are the Author’s own creation.

1.1 The five competitive forces that determine industry competition 12

2.1 The pairs of antinomies in forecasting 16 2.2 Evolution of scenarios over time 22 3.1 Macro and microenvironment 43 3.2 An application of Porter’s value-creating system model 48 3.3 IKEA’s value-creating system (ca. 2001) 49 3.4 Strengths and weaknesses checklist 52 3.5 Variations in the basic life cycle 53 3.6 Forecasting by analogy: radio vs. internet 57 4.1 Three different approaches to information 74 4.2 Main areas of consequences from the euro on

companies as expected around 2000 78 4.3 The usefulness of weak signals according to the

business strategy vision 80 4.4 The intelligence cycle 92 5.1 A generic procedure to build industry scenarios 101 5.2 Types of scenarios 114 5.3 Possible bifurcations in FSD development 116 5.4 Power mix: energy sources in % of total in 2030

in the two scenarios 122 6.1 World and European production of steel 126 6.2 European production of steel: actual data and

baseline projection to 2012 132 6.3(a) Main steel manufacturing countries in 1995 133 6.3(b) Main steel manufacturing countries in 2006 133 6.4 Trend impact of some exogenous variables on the

financial structure of an industry 142 6.5 Trend-impact analysis by curve fitting: typical event

impact parameters 146 6.6 Shipments of man-made fibres in Europe in 2010 148 6.7 Projected and actual deliveries of man-made

fibres in Europe 155 7.1 Crossed chances of winning of M and N soccer teams 159

List of Figures xiii

7.2 First Galba matrix 164 7.3 Second Galba matrix 165 7.4 Third Galba matrix 166 7.5 A framework for ESA competitive strategy towards 2020 176 7.6 A chart for ESA’s competitive strategy 177 8.1 The continuum operations strategy 188 8.2 From economic intelligence to the learning organisation 200 9.1 A family tree of choice theory 207 9.2 Country risk, political risk and sovereign risk 217 B.1 Cross-impact method with conditional probabilities 267 B.2 Sensitivity analysis: the elasticity matrix 272

xiv

List of Tables

5.1 Quantitative comparison between the two scenarios: energy mix and CO 2 emissions 119

6.1 World main manufacturers of steel in 2005 128 6.2 Variants of the FSD of the European steel industry 134 6.3 Events which may impact on the deliveries of man-made

fibres in Europe between 2005 and 2010 149 6.4 Events impacting on the baseline projections of

man-made fibres deliveries in Europe from 2006 to 2010 150 6.5 Configurations of man-made fibres shipments in

Europe from 2006 to 2010 152 6.6 Shipments of man-made fibres in Europe in 2010,

according to size of the impact 153 7.1 The main companies active in the production and

marketing for Galba around the year 2000 162 7.2 Strategic consequences for ESA of the 2–4 scenarios 174B.1 The conditional probability matrix 270

xv

Foreword

One of the greatest dilemmas facing decision-makers – whether in busi-ness enterprises, government agencies or nonprofit organisations – is the need to make long-term strategic decisions in an environment where the future is unknowable. During the 21st century the chal-lenges of forecasting beyond the immediate future have increased as a result of accelerating technological change, volatile financial markets, rapid social change and political instability. I see few signs of present turbulence giving way to a new era of stability. Turbulence and unpre-dictability have their roots in the greater interdependence and inter-connectedness of the world’s economic and social systems: factors that seem likely to intensify. In these circumstances, scenario analysis offers a systematic approach to thinking about how the future might unfold and an increasing valuable guide to strategic decisions.

Antonio Martelli is certainly qualified to write an authoritative guide to scenario building and planning. As an academic in business schools in Italy and other countries, a strategic planner for several companies and a management consultant, he has been a leading exponent of the principles and practice of scenario planning. This book not only offers a comprehensive guide to the techniques of scenario planning, it also distils the accumulated wisdom gained from applying scenario plan-ning at a wide range of organisations. As a result, Martelli is able to address the underlying conditions of uncertainty and complexity that make scenario planning so powerful in assisting managers to navigate the turbulence of their organisations’ environments. For the purposes of strategy formulation, scenario planning occupies an increasingly impor-tant place in the strategic management toolbox. In particular, it provides a valuable complement to the growing use of real option analysis in strategy development.

Equally important, Martelli shows that scenario planning is not only a technique to improve the effectiveness of decision-making in complex, uncertain environments, it also offers a process which enhances organi-sational learning, builds consensus, allows differences of opinion and interpretation to be voiced, and permits the surfacing of assumptions and cognitive biases. Overall, scenario planning can contribute signifi-cantly to increasing the flexibility of organisations and managers and to

xvi Foreword

counteracting the forces of inertia which inhibit adaptation and change among established organisations.

Robert M. Grant Professor of Management Bocconi University, Milan

Visiting Professor Georgetown University Washington, DC and

Cass Business School, Londonvn

xvii

Preface and Acknowledgements

The word “scenario” is nowadays in use all the time and everywhere. And yet what is meant by it is far from indisputable. Actually, the word conveys a lot of meanings and, if not clarified in a specific context, it easily gives way to confusion. This is not due to lack of analyses and explanations from theorists and practitioners. On the contrary, there is a flow of good or very good books and articles on the topic. But, as happens with words such as “organisation”, “structure” or even “democ-racy”, scenario has become a container of meanings, so that in everyday life everybody feels entitled to give it the meanings they prefer.

This book, however, is not about the semantics of the word nor is it a review of all its possible meanings. It is instead an analysis of the use of scenarios in the working out of strategies and in the decision-making processes of organisations. When scenarists have this aim, they must necessarily pass through two different phases, the building of scenarios and the use of them in planning the future of the relevant organisation. These two phases are not sharply separated; they overlap a lot, but a distinction there is. The book tries to clarify the links between them and how the first phase should naturally evolve into the second.

It is not certainly my purpose to make a case for scenarios as a sort of universal key opening very many doors. They have limitations: a scenarist I heard many years ago at a conference in Boston who was insistently asked on their limits burst in “you certainly cannot carry water in them”, a joke which might look silly but was rather a reminder that when a tool is presented the proper question is to ask what are the uses for which it is intended and not those for which it is useless. There are certainly many problems outside the scope of scenarios. Within that scope, there are instead four rather important tasks: reducing the uncer-tainty and complexity surrounding the future; improving the learning of managers and of organizations at large; helping managers in the framing of strategies; and helping them in the decision-making process. This is indeed quite a lot, and the description of how these tasks can be accom-plished by the scenario approach will absorb a large part of this book. In fact, scenarios, though by no means too difficult to understand and employ, to be really useful require a bit of time and patience, something which in today’s business environment is not abundantly available. This

xviii Preface and Acknowledgements

is probably the greatest difficulty to cope with in their use. And yet the rewards they may bring about are in many cases large enough to justify turning to the scenario approach for assistance.

The structure of the book is rather traditional, as it is organised around models for building scenarios and planning on their basis. It begins with the analytical premises of the scenario approach, Chapters 1–3; it proceeds with a digression on the use of information, intelligence and competitive intelligence, Chapter 4; it goes on discussing the building of scenarios, buttressed with 4 cases, in Chapters 5–7. Some of these cases are dated but, in the pursuit of transparency, I preferred to make explicit when they were worked out rather than resorting to the artifice of changing their dates. On the other hand, these cases are shown only as methodological examples: they are not meant to be used as supports of today’s strategic plans. Chapters 8 and 9 deal with the use of scenarios in planning, while Chapter 10 discusses who within an organisation is to carry out the scenario building and planning activity, and how.

There are then two appendices. Scenarios are not prepared in the void: in building them and planning on their basis, one should always have in mind how the environment at-large is evolving. Appendix A contains 14 tables on the most important present trends under way in the globalised world. These tables have been worked out consulting many sources on forecasts at medium and long term. The idea is to synthesise the “spirit of the times” as it may appear in the second decade of the 21st century. When projected into the future, trends are contradictory: how they will evolve into a coherent picture is, of course, a matter of speculation for many people, including scenario builders and planners. At the same time, these trends are a reminder for scenarists that they must deal with a lot of different issues.

Appendix B is a different character. Scenarios are about the future but they are not forecasts in the ordinary sense (they use forecasts a lot, however). Besides, as widely discussed in through the chapters, their basic premise is that, in any given moment, there is not just one future – there are many. This raises almost immediately the problem of the use of probability in building scenarios and in making decisions on their basis. On this, the opinion of scenario experts is varied. In general, some attribution of the probability of occurring to each of the hypoth-eses worked out in a scenario exercise is admitted, but the recourse to the formal probability theory is seldom advised – also because in the past it took to proposals at the limit of extravagance. But even if not explicitly employed, some basic knowledge of the basic principles of probability theory is useful to a minimum as a mental reference. This is

Preface and Acknowledgements xix

why I decided to avoid loading the main text with probability analyses, except in a very elementary form, and to add instead in Appendix B a short reminder of those parts of the theory which are most useful to the scenarist. Persons conversant with probability theory can certainly avoid reading this appendix.

Given the aim and scope of the book, I have concentrated on the mainstream of scenario theory and practice and left aside some specific applications, such as, field anomaly relaxation, backcasting, divergent mapping and others. I made this choice not because they are uninter-esting but just because of their specificity which warrants a treatment by somebody more acquainted with them than me. Scenario building and planning is a small discipline; nevertheless, it has grown enough to make it almost impossible for a single individual to master all its ramifi-cations. And moreover the book is already thick enough as it is.

The book is mainly about scenarios in business. Here and there, there are connections with the use of scenarios in other contexts also, but the emphasis in on scenarios and business companies, which is the context in which they are now mostly used, even if they are probably finding new areas of expansion in areas such as local governments.

As for the sources, with few exceptions those quoted are all in English. English is so predominant nowadays that books and articles published in other languages have just a “domestic” market. There are, for example, some good books and articles on scenarios in Italian which I know, but it would be pointless to list them as very few people outside of Italy could read them (the same could be said, of course, for other languages). Of the quoted sources, a large part are American and, in fact, most of the literature on scenarios comes from the United States and is also, for that reason, easily available.

The book reflects my experience, the things I did and the things I learnt. If I look back at my many years of activity, of which building scenarios was a sizeable part, I see them as following a flat parabola of sort. First, the ascent in the exciting years of economic rapid growth, then a long plateau of relative stability with moderate growth, inter-spersed with up-and-down fluctuations and marked towards the end by growing doubts about the resilience of the system; and finally the years of decline caused by the deep recession of 2007 and after – after which we know the world will not be what it was before. At the same time, the deep crisis became evident of the management and economic models which we had seen to grow and to evolve and in which we had become confident. I hope to look neither too naive nor too presumptuous if I say that a more extended and more knowing use of the scenario approach

xx Preface and Acknowledgements

would have avoided at least a few of the biggest mistakes made during that long period.

My thanks go to the colleagues and students of the Bocconi University and to the connected business school SDA in Milan, where I taught busi-ness strategy for many years with an emphasis on the use of scenarios. In the numerous discussions I had during those years, I certainly learnt more than I taught. The same holds for the other universities in Italy and elsewhere, where I held courses on business strategy and/or scenario building and planning, as well as for the many companies and institu-tions, in Italy and abroad, I worked with as consultant. I then thank most heartily Professor Robert Grant, who encouraged me to write this book, provided the first contact with Palgrave Macmillan and agreed to write a foreword. My two friends, Professor Giuseppe Scifo of the Libero Istituto Universitario Carlo Cattaneo in Castellanza, Italy, and Dr Maurizio Donnini, who for many years ran a successful management consultancy in Milan, read the manuscript and provided extensive comments and criticisms which certainly improved the quality of the book. With Dr Milena Motta of the Italian unit of Strategic Competitive Intelligence Professionals (SCIP) and a renowned consultant on the subject, I discussed and applied many times the principles of competi-tive intelligence in scenarios and war gaming and learnt much in the process. Jane Voss of the University of Rouen checked the English text thoroughly and made so many amendments as to make it quite a different thing from what it had been. Finally, I owe much to my partner Cinzia Alberti as well as the rest of my family, who sustained with patience and grace the nervousness known to anybody who ever had the dangerous idea of writing a book.

xxi

List of Abbreviations

BP baseline projection CAE carbon emissions CAGR compound annual growth rate CI competitive intelligence CIA cross-impact analysis CNR National Research Council CSI customer satisfaction index ECI energy consumption index ERP enterprise resource planning ESA European Space Agency ESI employee satisfaction index EVA economic value added FSD fundamental system drivers GDP gross domestic product GNP gross national product HCVA human capital value added HLG high-level group I&WA intelligence and warning analysis IL intuitive logic IPS innovation pipeline strength KIT key intelligence topics M&A mergers & acquisitions MA morphological analysis MGR market growth rate NLP neurolinguistic programming NOPAT net operating profit after taxes OECD Organisation for Economic Co-operation and Development PEL production of electricity PEST political, economic, social and technological PPE production of primary energy PPP purchasing power parity QI quality index R&D research and development RBV resource-based view RDS Royal Dutch Shell

xxii List of Abbreviations

RFID radio frequency identification RII return on innovation investment RMS relative market share ROA return on assets ROI return on investment ROE return on equity SB scenario building SBP scenario building and planning SBU strategic business unit SCIP Strategic and Competitive Intelligence Professionals SI spheres of influence SMEs small and medium enterprises STEER sociopolitical, technological, economic, ecological and

regulatory SWOT strength, weaknesses, opportunities and threats TF technology forecasting TIA trend impact analysis TMI time to market indicator TROI training return on investment VUCA volatility, uncertainty, complexity and ambiguity WACC weighted average cost of capital WRI waste reduction index