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September 2008

Risk Management

The September 2008 issue of Harvard Business Review has two excellent articles on risk management, both written by consultants at McKinsey. The first one, entitled "The New Arsenal of Risk Management", provides a fascinating historical perspective on risk management in finance and beyond. I'll discuss it here, and keep the second article on "Owning the Right Risks" for my next post.

In this first article, the authors identify the 1973 option-pricing model developed by Fischer Black and Myron Scholes, as well as Robert Merton, as a watershed moment in risk management, and tie the underlying ideas to the concept of real options, i.e., options on capital investment (such as renting or buying a new warehouse, cancelling a project, postponing a product launch, etc). The advantage of real options is that they "put a value on managerial flexibility", in contrast with Net-Present-Value calculations, which lead to only one number and don't capture the array of decisions available to the manager. I found the exhibit on the evolution of risk management from the 1950s on particularly illuminating.  

The authors then describe the parallel trajectories of the risk management techniques and computational tools available over the last few decades. It is easy to forget now that hand-held electronic calculators have not always been around, and that there was a time where you couldn't run business simulations off a PC using Crystal Ball or @Risk. Even now, the fact that one needs an Excel add-on to generate most random variables meaningful in real life speaks volumes about the public's lack of understanding of simulation tools and their importance to practitioners (otherwise, industry licenses wouldn't cost thousands of dollars a piece.)

After connecting the debt-to-equity ratio with the probability the company will suffer losses, and discussing how to mitigate risk in high-level terms, the authors focus on risk in financial services, with a number of one-sentence anecdotes that will make many readers look up details of each case on the Internet (the collapse of the Herstatt bank in 1974, illustrating settlement risk in foreign-exchange transactions, and the 1991 failure of the Bank of New England come to mind. The BNE case is eerily similar to recent developments at Washington Mutual.)

They point out the main issues in the mortgage crisis, such as the fact that "the ability to estimate credit-risk exposure has not kept pace with the growth in credit-risk instruments" and the creation of "counterparty credit risk" when companies trade risk with each other. (Baltimore's City Paper has an entertaining example of counterparty risk that illustrates the challenge created by derivatives quite humorously. For August predictions on counterparty risk that turned up true this week, read this article from Wall Street Journal's Market Beat.)

The New York Times explains in its article about Washington Mutual that "The government has dealt with troubled financial institutions differently. Lehman Brothers and Washington Mutual, which were less entangled with the rest of the financial system, were allowed to collapse. But the government took emergency measures to stabilize Goldman Sachs, Morgan Stanley and the American International Group, the insurance giant." We could call this the "jump off the bridge" principle. People are always more motivated to stop someone from jumping off a bridge when that person is threatening to take down innocent bystanders with him. Maybe Lehman and WaMu hadn't made themselves necessary enough - a sad end to impressive success stories. Ironically, their demise might be due to the fact that they weren't troublemakers enough.      

The Harvard Business Review comments in some detail on Goldman Sachs, today "essentially in the business of managing risk" and gives four factors explaining the company's success: (1) recruiting quantitative professionals (the article names Fischer Black, hired from MIT, Emanuel Derman, now at Columbia, and Bob Litterman, "a codeveloper of the Black-Litterman global asset allocation model", that one of my former students praised just a few days ago, (2) strong oversight ("daily risk reports detail the firm's exposure with [...] stress tests showing potential losses under a variety of scenarios"), (3) partnership heritage (the idea that employees own part of the firm), and (4) business principles, and in particular the emphasis on behaving in a way that maintains the company's good reputation rather than being afraid to lose the company's money.

The article ends with a discussion of the energy sector and its attempts at risk transfer through energy futures markets, and a warning from the companies that have "stayed on the sidelines" and thus avoided the crisis: this behavior "has also prevented them from growing as quickly as they might have." The authors explain how risk techniques can be used by any industry practitioner in their second article, which will be the topic of my next post.

Web Searches

When people stumble on this blog after typing a query in Google, I can read that query on the blog's statistics page, and I have to say some amaze me to no end. Like this one, this afternoon, from Canada: Analyze the basis that might have led Michael Porter to make the comments noted above. Discuss the validity of the points that he is making. Comment on the application of this statement to an industry.

That type of query amazes me for two (related) reasons. The first one is, of course, that students would hope a worthy term paper would be available for free on the Internet, and their teacher wouldn't find out. Don't the kids realize teachers know about the Internet too? Tools to fight online plagiarism, like Turnitin, are now offered on Blackboard [online course portal where students can download assignments, lectures, etc posted by the instructor in all of their courses - this removes the need for professors to make their own course webpage and has a lot more capabilities, such as online grade management, wikis, group pages where all users can post documents]. While my courses don't easily lend themselves to essays, I have run students' papers by Turnitin when financial engineering grad students had to perform literature reviews, and have done so for answers to qualifier exam's questions. It is naive for students to expect they can find essay answers on the Internet. Besides, they might not be the only ones hoping for an easy way out of the assignment (I often see clusters of such queries on the blog's statistics page), and plagiarism is a recipe for trouble. This speaks volumes about students' opinion of their teachers' "technological literacy".

The second reason for my amazement at such queries is that people treat search engines as cultivated uncles who understand human language. This naivete about what the Google search engine can and cannot understand is reflected in another observation I have made: even if people don't enter whole sentences, they often type without quotes groups of words that they clearly want to find together. This is going to sound like a technical, obscure matter, but how can people master the capabilities of search engines and find the information they are looking for if they don't even know that, for Google or Yahoo or MSN to look for an expression as typed, one has to put the expression between quotation marks? Typing it without quotes tells Google to return only pages that have both words somewhere in the text, but not necessarily close from each other. People then end up with thousands more results, many of which are irrelevant to the original query. They will sift through the first few pages of links and, if they are looking for something off the beaten path, will give up on their search before reaching the link that would have truly answered their question, but is buried far down the list. 

I don't even think in terms of sentences when I type queries such as +"auction-rate securities" +wsj In addition to the quotation marks, explained above, the + symbol tells Google I want both groups of words; if I had typed - in front of wsj [Wall Street Journal], that would have meant I didn't want any article that had wsj in it. I have become so used to that type of search I don't think twice about it - it's just a routine query. Then again, I am an engineer. Many people can handle typing quotes into a search box, but think about all those who take pride in not being good at math, faced with the prospect of having to write mathematical symbols to get the information they need - imagine the look of horror on their face. Some will undoubtedly prefer setting themselves up for failure rather than dealing with pluses and minuses.

Teaching Journalism

I enjoyed reading this post by Mindy McAdams on rethinking the education of journalists. The topic is a little far from my area of teaching (engineering), but the article makes good points that many people will find relevant. The debate on whether journalism should be taught in a college undergraduate program or in a trade school, for instance, echoes the more general discussion of the purpose of college education and the role (or right) of the companies that hire a majority of the graduates in shaping the curriculum. Which skills should be acquired in school and which skills should be acquired on the job?

Students in industrial engineering, for instance, can follow a wide range of career paths - in finance, consulting, supply chain management or production management. They also might change fields at several times in their career. Should college prepare them to that? Or should these students resign themselves to going back to school (full-time, part-time or online) when they want to make a career change? The post's author states: "The years spent at university as an undergrad are not meant to be job training." MBAs are, after all, professional degrees. Master's degrees typically do not require any of those breadth requirements that liberal arts students required to take a physics lab course complain so heartily about. On the other hand, PhD programs often mandate that students take two or three courses outside their department to balance their skills and avoid over-specialization.

At least many of our industrial engineering students pursue a business or economics minor. Journalism students, it seems, prefer minoring in English or in sociology rather than what the post's author calls "smart minors" such as political science or environmental science. She explains: "Why don’t college students pursue smart minors? I think it’s because most of them don’t know what they want to do. [...] I think this explains why so many of them just stay in school, getting a master’s degree in something they also probably won’t end up pursuing as a career." I personally doubt that this applies to the majority of Master's students, at least in engineering, if only because it costs a lot to stay in school one more year - and if students should be congratulated if they are smart enough to realize that taking a first job in an area they end up not caring about might make it more difficult from them to move to another, more interesting but completely different, field. There's nothing wrong in taking one more year to figure things out.

Postponing the entry in the real world for lack of a better plan definitely plays a role in some students' decisions to apply to doctoral programs, where schools guarantee funding for at least the first year of study in PhD programs - allowing introspection and a Master's degree for free for those who don't really want to get a PhD. But what about the students who follow the path of least effort, go to graduate school because they have grades good enough to be admitted, never figure out why they are there or what they want to do (by introspection or because of outside circumstances), and just float around, stuck in college mode? Those will end up wasting years of their life for nothing to show in return.

To go back to undergraduate programs - I was struck by that sentence in the post: "All the students who go through a four-year journalism program and earn a bachelor’s degree in journalism have, at the very least, a good idea of how journalism works, when it fails, and when it reaches noble heights. If they come out and never, ever take a single job in journalism, they will retain that knowledge." That is very close to the rationale we give students when we try to convince them to become engineering majors, except that we replace "when it reaches noble heights" by "how to develop quantitative problem-solving skills" - admittedly a less lofty goal.

Auction-Rate Securities

The August 16th issue of The Economist has an article about auction-rate securities, a debt instrument that allows municipalities, among others, to issue long-term debt (meaning they don't have to repay the debt for a while) while taking advantage of lower short-term rates, because the rates were set monthly or weekly at auctions - hence the name. (Long-term debt usually calls for higher rates because investors need to be compensated for losing access to their money for extended periods of time) From a buyer's perspective, the instruments were attractive because they were marketed as near-cash, due to the frequent auctions. Unfortunately, the market for ARS froze in February, when the auctions failed. Back in February, the New York Times reported that "Goldman, the most celebrated bank on Wall Street, refused [that week] to let [some well-heeled investors] withdraw money from investments that they had considered as safe as cash."

This created an outcry among investors (the New York Times quotes one of them as saying that "it's a moral outrage") and has led to litigation and, now, settlements. For instance, in The Economist's words, "UBS, Citigroup and Merrill Lynch have agreed to buy back more than a combined $41 billion of ARS and pay at least $250m in fines." JPMorgan and Morgan Stanley "will repurchase a combined $7 billion of the troubled securities from investors at face value. Morgan Stanley agreed to pay a fine of $35 million and JPMorgan will pay $25 million," according to the Associated Press. The International Herald Tribune announced yesterday that "Credit Suisse Group will buy back $548 million in auction-rate securities and pay a $15 million fine to settle a probe into the sale of the risky investments to retail investors." (The auction-rate securities market is also at the center of a bait-and-switch scam by two Credit Suisse brokers who falsified email confirmations sent to clients and "replaced any mention of the words 'mortgage' or 'CDO' with 'student loan' or 'education'" because their clients did not want to purchase mortgage-backed securities. The things people do to get their commissions.)

Much of the news coverage has been supportive of the investors. The Los Angeles Times started one of its articles with "Good news for investors trapped in so-called auction-rate securities: State regulators are feeling your pain," and another one with "More on regulators' probes into so-called auction-rate debt, which have caused misery for thousands of investors who have become trapped in the securities amid the credit crunch": doesn't that make you feel these investors could be your next-door neighbor? But the New York Times back in February mentioned that "the banks typically pitch these securities to corporations and wealthy individuals (as safe alternatives to cash)", and according to Wikipedia, "the minimum denomination [is] $25,000 or more", which certainly explains why the pitch isn't directed at the average Joe.

The Economist does not mince its words toward such investors: "The risks were disclosed. Marketing documents spelled out the possibility that auctions could fail. [...] Many of the 100,000 or so retail investors were well-to-do types and thus clued up enough to understand that higher yields suggests higher risk." Of course, the picture is not quite as simple - higher yields suggests there is a trade-off hidden somewhere, and one can argue that they are simply an incentive so that people will spend the non-negligible amount of money required to enter the market. The whole story also raises the question of quantifying risks - auctions could fail, but did investors understand the likelihood of it happening? "Many clung to their paper despite having several turbulent months to cash out," says The Economist. It is possible that people, even sophisticated ones, are no longer willing to stomach a loss. After the ARS saga, "banks' shareholders could even start to sue them over moves such as the ARS buy-back." Being a lawyer in the current environment sounds like a good career choice.


On Sunday it seemed that you could find a homeless person whispering for money on every block of Madison Avenue on the Upper East Side. Starting early this summer, the number of homeless people I noticed in New York City's midtown and uptown skyrocketed - in the four years I have come regularly to NY, I hadn't seen nearly as many of them in Manhattan. Of course, there were always a few, but suddenly they are everywhere. And later that afternoon, I learned, from someone with first-hand knowledge of these things, that the Metropolitan Museum slashed its educational budget by half because of the poor economy. The museum has in particular cut the number of free public lectures it offers (if you are a young professional, you might have noticed the "observant eye" lectures [aimed at the 20-to-40-year-old crowd] are no longer on the calendar). This can have two possible reasons: dwindling numbers of members or decrease in endowment wealth, both related to the current financial crisis - even if the endowment stays strong, people are more reluctant to give when they worry about layoffs or smaller bonuses. Because of the sheer number of Metropolitan donors and the small fee associated with entry-level membership (individual yearly membership is $95, which - given how much everything costs in NY - really doesn't amount to much, and on top of that it's tax-deductible), I hadn't expected the museum to be hard hit by the crisis, but of course the $95 donors aren't the ones who pay for the new paintings and the new galleries. The highest level of giving is $20,000, and odds are that many wealthy donors have made their fortune in either finance or real estate, two segments of the American economy that are not exactly thriving right now.

I remember strolling away from the museum on Sunday, walking by homeless man after homeless man on Madison, and wondering whether the media has been doing a good job conveying the full extent of the crisis. Then Monday's events happened and the extent of the crisis suddenly became very obvious to all.

Pricing and Market Share

The Economist dated August 16 has a good article on the "hard discount" model of supermarket retailing. Discounters such as the German Lidl and Aldi "generally charge 30-50% less for groceries," and it will come as no surprise that they have been increasing their market share in the current economy.

In particular, the article describes some of the operational details that are necessary to make low prices sustainable. It is easy to think about lowering prices to gain market share and increase volume, but the cost structure is an important element to take into consideration too. In highly competitive environments, the level of prices one can offer while remaining in business is closely related to the costs one incurs. "Discounters stock a fraction of the goods that a normal supermarket offers, resulting in fewer suppliers, a high volume of purchases and sales, and massive economies of scale."

Not only do customers have less choice (and often no choice at all) between brands, but "discounters mostly sell their own private-label goods." This is a cost-saving measure because brand owners take a percentage of the revenue. The article also notes the impact of hard-discounters on customers' buying habits (and their move upmarket), and gives examples of competitors that have slashed prices although they are not hard-discounters. It mentions Germany is "the heartland of discounting", but fails to explain what made it possible for this business model to thrive in that country. My guess is that Aldi's and Lidl's German success are due to post-World War II living conditions; both chains have been around for decades.

While Lidl recently retreated out of Norway after a four-year experiment, this policy change doesn't seem to be due to customers' disinterest; instead, the company's zoning requests and building permits were apparently turned down repeatedly by bureaucrats. Similarly, according to The Economist, "[Aldi and Lidl] are expected to expand quickly in France now that a law designed to keep discounters out has been changed."

This excellent article in Britain's The Telegraph explains part of the appeal of Lidl in more specific terms (including aisle design, surface/size, staff numbers, number of product lines, and little tricks such as the fact that "all packaged products have barcodes on every side so that they can be swiped through a scanner faster.") Both The Economist and The Telegraph agree that we are seeing a new brand of shoppers, whom The Telegraph calls "hybrid", shopping at hard-discount stores for some products and at traditional stores for others.

Another valuable read is Aldi's formula for success: small selection, low prices, by Mike Hughlett of the Chicago Tribune about Aldi in Chicago. The focus on costs of hard discounters is underlined in this interview with Aldi's UK boss in The Guardian, which mentions items we shoppers view as free but are of course not (instead, their cost is hidden in the price of the goods we pay) - shopping carts that work without deposit, meaning that the company needs to pay employees to round them up, and grocery bags as well as the employees who fill them. You can also learn the following in the Guardian's article: "Aldi is rated the ninth best place for graduates to get a job in an annual survey by The Times [in part because of high starting salaries]. It is ranked higher than many of the City's money factories, including Goldman Sachs, and above corporate giants such as Shell and GlaxoSmithKline." Who would have thought.

Math and the Fear Game

People good in math used to be called geeks and nerds - nothing too flattering, but nothing to feel afraid of either. They were left to their own devices, first in high school, then in the back office of financial companies where they programmed or analyzed data all day long, while the rest of the population took pride in their mathematical illiteracy, or at least behaved as if it was no big deal. The importance of quantitative techniques in business, and in turn in the life of anyone who buys products from companies using such techniques (including, Fedex, UPS, Dell, and countless others), is slowly being recognized through books like Super-Crunchers and The Numerati. It is wonderful to see operations research - which is a fancy name for mathematical modeling to help companies improve the way they operate - pushed into the limelight, after years of running the show backstage.

But it is true that operations research (OR) is not completely unknown to the general public - everyone who has ever bought a plane ticket online has witnessed the result of complex algorithms, and few people enjoy the feeling math is helping big business rip them off. So we are faced with the following problem: most people don't realize what OR is, and those who do don't like it, because it is helping companies squeeze more money out of their customers. This is why OR (and the people who represent it) needs to stick to its message of helping customers by providing faster service - speeding up deliveries, keeping call centers staffed - and helping a wide range of companies stay in business. (The more competition, the lower the prices.)

That is why I find the choice of the British cover for The Numerati by Stephen Baker - you can see a picture at ThinkOR - singularly ill-advised. The subtitle "How they'll get my number and yours" made me cringe. So first we're instruments of greed, and now we're stalkers? Gosh. Next thing you know, we'll be beating up old ladies in dark alleys. (The ThinkOR post's author also wonders whether "casting OR folks in an evil light" is really a good idea. No kidding.) People I'd like to see pick The Numerati in a bookstore are non-OR professionals who read other business-oriented books to remain competitive in the workplace, and maybe the odd parent trying to figure out the hot career prospects for Junior. (And of course OR people thrilled to see their line of work get some recognition. Yes, I bought the book.) These are the people who should feel drawn to at least open The Numerati. I am not convinced a "scary" cover achieves this, but it is interesting that someone in a marketing department somewhere thought it would. Maybe that person needs more focus groups, more numbers - and more numerati to analyze them.

Science, Education and Politics

By now, many people already know who they will vote for come November, and it is doubtful the undecided will use candidates' position on science and technology as a tie-breaker. A handful of bloggers and activists have taken upon themselves to track Obama's and McCain's stands on teaching and funding science, though, and their work deserves to be put in the spotlight. (Disclosure #1: don't try guessing who I am going to vote for. I am not a citizen, so I cannot vote. Disclosure #2: I found all of the links by reading this excellent post from Cocktail Party Physics.)

Science Debate 2008 is a citizens' initiative co-sponsored by the National Academy of Engineering and the National Academy of Sciences, among others, and signed by members of over 175 leading American universities, including Lehigh President Alice Gast. It compiles links to recent news stories, and lists 14 questions it crafted based on public input. Obama's answers are provided here; McCain has yet to respond.

In particular, Obama plans to "double basic research budgets over the next decade." (A Chronicle of Higher Education columnist points out that "assuming Obama is talking about dollars not adjusted for inflation, which is how Washington normally discusses the federal budget, a 10-year doubling would approximately restore the pace of research growth that prevailed for many prior decades governmentwide.") He also plans to create Service Scholarships (to pay for "undergraduate and graduate education costs for those who commit to teaching in a high-need school"), develop Teacher Residency Academies (to add new teachers to high-need schools), and increase the number of National Science Foundation graduate fellowships.

Education is the focus of Question 4. Some proposals sound awfully vague ("[Obama] will support research to understand the strategies and mechanisms that bring lasting improvement to STEM [Science, Technology, Engineering and Mathematics] education") Others are more specific: the $4,000 American Opportunity Tax Credit aims at making higher education more affordable. Obama's website offers more detailed proposals on education, although of course the amount of money that ends up allocated to them will play an important role on their ultimate success or failure.

His policies make a lot of sense: address the high school dropout crisis, support college outreach programs, recruit teachers (by paying for their education in exchange for four years of service), create the tax credit above "which will cover two-thirds the cost of tuition at the average public college or university and make community college tuition completely free for most students", and simplify the application process for financial aid. Now, of course, the question is: where is the money going to come from? But at least the intention is there.

In contrast, John McCain's page on education focuses on parents' right to school vouchers and homeschooling: "Public education should be defined as one in which our public support for a child's education follows that child into the school the parent chooses," "John McCain will fight for the ability of all students to have access to all schools of demonstrated excellence, including their own homes," "John McCain will place parents and children at the center of the education process, empowering parents by greatly expanding the ability of parents to choose among schools for their children." This is a valuable goal, but the plan is short on specifics when it comes to improving the worse schools. You cannot simply hope that the better schools will find room for many new students; in addition, an influx of students might change the way kids are taught (for instance by increasing the number of students in class) and turn good schools into bad ones.

The reader following the link to "John McCain's plan for strengthening America's schools" will be faced with more vagueness and grand-sounding sentences. An example: "John McCain Will Enact Meaningful Reform In Education. Now is the time to demand real, new reform earned through discipline, grinding work, tough choices and leadership. John McCain has dedicated his career in public service to the hard and sometimes unpopular work of achieving meaningful reform." And that's it. Then he moves to the next point, never bothering to answer which meaningful reform he is actually referring to. He might have good ideas, but he certainly hides them well.

Obviously, part of it is due to the philosophical differences between Republicans and Democrats when it comes to taxes and federal programs - maybe suggesting scholarships to pay for math and physics teachers' education would be treated as heresy by the Republicans, because the program would need to be funded somehow. Yet, I have a hard time understanding what exactly McCain plans to do to fix the educational system, once he's handed out all the school vouchers.

Whether one agrees with Obama's plan or not, his team has gathered comprehensive statistics that suggest at least someone on the Obama side is aware of the specific challenges America faces from kindergarten to college - that's a good start. For instance: "College costs have grown nearly 40 percent in the past five years," "the average graduate leaves college with $19,000 in debt" (and that's only the average, mind you), "between 2001 and 2010, 2 million academically qualified students will not go to college because they cannot afford it."

One also learns that "over 1.5 million high school students failed to apply for aid in 2004, despite being eligible for a Pell grant," possibly because the application is 5 pages long and has 127 questions. (Yes, 127.) The one thing that bothers me a little is that, in the same way that some proposals above focus on high-need schools, although good students might be the ones who need superb teachers the most (to bring them to the level where they can make a difference in American innovation), the "costs of complexity in [the] financial aid system" are explained here to fall most heavily on "non-English speaking youth." Well, I don't know, but if they don't speak English, I don't think their odds of succeeding in college are that great to begin with. But this change would benefit every student who is indeed going to college, white and non-white, and that's what matters.

Obama has plenty of additional ideas, for instance regarding community colleges, that I won't discuss here. That doesn't mean he'll be able to implement them if he becomes President. But at least he is making concrete proposals, all of which that sound sensible. McCain, in contrast, has hurt his chances with the science-minded crowd by choosing as his Vice President someone who wants creationism taught in schools (under the disguise of "teach the controversy") and denies the evidence of global warming.

So it really doesn't look like science-minded people should spend a lot of time deciding who to vote for. The question is: how many science-minded people are there in America?

Scenario Planning

This week's management idea featured in The Economist is scenario planning - the first idea in the series that applies to quantitative decision-making. The series is based on an Economist-published book. When I read the list of management thinkers profiled, I was struck by the absence of any quantitative researcher; instead, self-improvement gurus such as Stephen Covey and Dale Carnegie made the list. They have indeed sold millions of books and helped countless people improve, and yet, they don't belong in the same category as business school luminaries such as Michael Porter, Warren Bennis or Rosabeth Moss Kanter, at least in my opinion.

But it is true that you cannot easily associate one name with the quantitative practices that, today, allow to ship packages in the most efficient way and local retailers to manage its supply chain or put products on sales. This (and many people's distaste for anything math-flavored) has allowed the importance of quantitative methods to recede in the public's consciousness. Instead, The Economist describes at length crisis management (do we really need a definition?), succession planning, competitive advantage, and skunkworks (a place "designed to encourage the employees of large organisations to come up with original ideas").

Even scenario planning, in this week's lone quantitative-oriented feature, is linked to what we will politely call an atypical figure (Pierre Wack, an incense-burning follower of mystic Georges Gurdjieff - known for his hold over architect Frank Lloyd Wright, among others - and executive at Royal Dutch Shell in the 1970s). Note that scenario planning is here used to envision disruptive changes, and does not refer to tomorrow's product being a great success or an abysmal flop. The article hints at the woefully inadequate methods used by industry: in the 1970s, there was "widespread dissatisfaction with [...] straight-line extrapolations from the past." No kidding. The article goes on quoting worrisome numbers from a Bain&Company study: "fewer than 40% of companies used scenario planning in 1999. But by 2006 its usage had risen to 70%." The thought that almost a third of the companies surveyed do not even try to imagine how their business could be disrupted does not exactly inspire confidence. With all the talk about building resilient enterprises, you would have thought the vast majority of companies would have bothered to develop contingency plans.

I found The Economist article somewhat disappointing because it remains very vague and is of no help to people interested in applying this concept. (Also relevant is the 2001 Economist article on the same topic, viewable by subscribers only.) Part of the reluctance in applying scenario planning might be that the people who are asked to come up with disruptive ideas are the same individuals who are managing the business on a daily basis - most cannot be thrilled about imagining what big, bad things could happen, because they have so many little things go wrong every day, and those are already hard enough to correct.

Participants to the 2001 conference offered the following disruptive ideas: "the Colombianisation of Mexico, the positive economic effect of later retirement and the emergence of Europe as the world's superpower." I doubt those ideas would be the first to cross people's minds if the same question was asked today. The danger with scenario planning is that people will try too hard to predict the future instead of predicting possible disruptions on their business - if a supplier is unable to ship a big order, you don't care if it's because there was a fire, an earthquake, a strike at the docks, or a popular uprising that has the government declare an emergency. In other words, what creates the disruption is a lot less important than its outcome. Nobody could have predicted the terrorist attacks on New York City. But "as a result of its scenario planning, the New York Board of Trade decided in the 1990s to build a second trading floor outside the World Trade Centre, a decision that kept it going after September 11th 2001."