March 04, 2013

Scenario Planning: Warren Buffett, Gottfried von Leibniz, Blaise Pascal, and Peter Bernstein

Gerard Smith
Managing Principal

I recently came across a 2004 Money Magazine interview with the late Peter Bernstein, an investment manager and economic historian and author of Against the Gods: The Remarkable Story of Risk, among other books. Bernstein, who died in 2009, may not be as familiar a name as Berkshire Hathaway’s Warren Buffet, but the interviewer’s description of him as a “Yoda” of Wall Street makes him seem a lot like the Sage of Omaha.

What particularly piqued my interest was the headline –  

“…Peter Bernstein may know more about investing than anyone else alive. And the most important thing he knows is this: He has no idea what the future will bring.”

Now in our line of work, if that doesn’t tickle your fancy, nothing will, as scenario planning is based on the premise that the future is unknown, and the usefulness of scenario planning is in decision making under uncertainty, particularly when the stakes are high.

And as I read through the interview, I couldn’t help seeing strong parallels between Bernstein’s perspective on investing, and FSG’s on strategy. Here are the key points of convergence:

1. Extrapolation is the most common mistake–the refusal to believe that shock lies in wait (or that anything other than present conditions or current trends will apply).

2. Understanding that we do not know the future is the surest way to reduce the risk of overreaction to a surprise.

3. The riskiest moment is when we’re right. That’s when we are in the most trouble as we tend to overstay the good decisions.

4. Diversification is an explicit recognition of ignorance (for the same reason, scenario planning will always consider a broad range of plausible changes in an organization’s operating environment).

5. Nature works in patterns, but only for the most part (Leibniz). The unpredictable part tends to be where things matter the most–that’s where the action often is.

6. Consequences are more important than probability (Pascal). Strategy should always be stress tested for sensitivity to a range of operating environments. (In other words, “high impact” always trumps “low probability,” and “low impact” trumps “high probability.”) 

7. There can be paradigm shifts, when our view of the future changes dramatically and suddenly. 

8. Markets (and we would argue, most aspects of our culture) are shaped by memory banks–experience shapes memories, and memory shapes our view of the future. So if events are separated by more than say, 20 years, a whole generation will behave in a different way.

So print this list using a large font, pin it on the wall of your office and preferably, your boardroom, and get everyone to read it out loud next time you or your organization is weighing an important decision.

Then call FSG.

 

Thoughts?