When outside uncertainty hits: change your options, not just your forecast

When the outside world becomes uncertain, the usual response is to revise the forecast. Inflation rises, so cost estimates go up. Interest rates move, so finance costs are recalculated. A supplier’s lead times stretch, so a contingency is added. A key market looks shaky, so sales are trimmed. All of this is sensible when uncertainty changes the value of things the business already understands.

It is not enough when uncertainty changes the shape of the decision itself. A border closure, a financing freeze, a regulatory decision or the failure of a sole supplier does not just change a number in the model. It can change whether the business can operate, where it can operate, how it can be financed and which options it actually has. Revising the forecast in those cases produces a more precise description of a plan that may no longer be possible.

This article explains how to distinguish uncertainty that changes economics from uncertainty that threatens continuity, four broad ways to respond, why inflation and finance can create chains of consequences, why reversibility has value, and how to set triggers so that alternative plans are actually used when they are needed.

Uncertainty that changes economics, and uncertainty that threatens continuity

Research published in the Harvard Business Review in 2019 by Ben Laker and Thomas Roulet, based on interviews with executives facing political uncertainty, drew a useful distinction between two kinds of uncertainty:

• Economic uncertainty changes costs, prices, exchange rates or demand. The business can still operate, but its margins and competitiveness shift.
• Continuity uncertainty threatens the ability to operate at all. Goods cannot cross a border, a service cannot be delivered, finance becomes unavailable or a critical activity can no longer be carried out where it is.

The responses should differ. When economics shift but continuity is intact, a business may adjust prices, rebalance its exposure or protect itself against the worst movements. When continuity is threatened, more fundamental action may be rational: preserving cash, developing alternative suppliers or locations, reducing commitments that cannot be reversed, or moving activities elsewhere.

The labels in the original article were tied to a particular political situation, but the distinction applies widely.

Four broad responses

The same research described four broad responses, which can be interpreted generally as different degrees of reallocating resources. Which one fits depends on how severe the threat is and how attractive the affected market or activity remains:

These are not mechanical categories. Their value is in forcing a business to connect a specific change in the environment to a specific action, rather than applying the same plan whatever happens.

Uncertainty can be an opportunity too

Not all outside uncertainty is bad. During disruption, competitors may freeze investment, good staff may become available, equipment or premises may become cheaper and customer needs may shift in ways the business can serve. A business that only defends may miss the moment when disciplined action would have gained ground. Ask what the change makes possible, as well as what it threatens.

Inflation is more than a number in the model

When inflation rises, businesses rightly update their cost estimates. Two further points matter.

First, keep the model consistent. If future cash flows include expected price increases, they should be assessed with a rate that also includes inflation. If cash flows are in today’s dollars, the rate should exclude it. Mixing the two can make an investment look much better or worse than it is. Say clearly in any forecast whether inflation is included and how.

Second, watch whether inflation is changing behaviour as well as prices. Suppliers may shorten the period their quotes are valid. Customers may delay purchases. Lenders may tighten conditions. Staff may expect faster wage increases. At that point, inflation is no longer just a modelling input. It is changing how the business and the people around it operate, and contracts, pricing and purchasing may need to change too.

Finance can create a chain of consequences

A change in financing conditions can trigger a chain of effects. A lender delays a decision or raises the cost of a loan. The delay pushes back a project. The later start raises equipment and construction costs. Higher costs weaken the investment case. A weaker case makes finance harder to obtain or refinance. This is a feedback loop, not a single risk event, and it can turn a sound project into a struggling one without any change in the project itself.

The practical response is to watch financing conditions as closely as project progress, keep some headroom in cash and borrowing capacity, and avoid plans that depend on everything happening on time.

Reversibility has value

When uncertainty is high, the ability to change course becomes worth paying for. Examples include:

• staged investment, where later stages depend on conditions being met;
• leasing rather than buying equipment or premises;
• a pilot before full commitment;
• a second supplier, even at a slightly higher price;
• shorter contracts that preserve options, even at a higher unit cost;
• cash reserves that look inefficient in calm periods but allow action when finance tightens.

Flexibility has a cost, and it is not always worth paying. The question is whether the value of keeping an option open justifies its cost under the uncertainty the business actually faces. The best long-term technology may not be your next investment article looks at sequencing investments when the future is unclear.

Look for shared exposures

Separate plans and projects can depend on the same outside condition: the same currency, the same regulation, the same supplier or the same lender. Each risk register may show a manageable risk, while together they amount to a concentrated exposure that one event could hit all at once. Once or twice a year, list the outside assumptions behind the business’s main plans and look for those that appear more than once.

Turn contingency plans into triggers

Many businesses have contingency plans that are never used, because nobody agreed when to use them. Each new development can be interpreted as temporary, so the switch never happens, or happens too late.

A stronger approach is to attach triggers to alternative plans: specific, observable conditions agreed in advance. For example:

• if the cost of borrowing rises above an agreed level, defer the next stage of investment;
• if a supplier’s lead time exceeds an agreed number of weeks, activate the second supplier;
• if orders from a market fall by more than an agreed share for two consecutive months, redirect stock to other channels;
• if an approval is delayed beyond a date, redeploy people to another project;
• if an operation cannot continue at its current site, move defined activities to an agreed alternative.

Triggers turn uncertainty planning into something the business can actually carry out. The plans that detect rather than predict article covers how to design triggers more generally.

Commit, stage or keep the option

When outside uncertainty is material, sort decisions into three groups:

• Commit now: choices that make sense across all plausible futures.
• Stage: choices that look attractive, but where learning more before full commitment is valuable.
• Keep the option: choices where current uncertainty makes an irreversible commitment unattractive, so the business preserves the ability to act later.

This turns one fragile plan into a set of responses that can hold up across different futures.

Five questions when uncertainty is material

A worked example

This is an illustration. A specialty food manufacturer exports about 30% of its output to one overseas market and buys its main packaging from a single overseas supplier. It is planning a $600,000 expansion of its production capacity, financed mostly by a bank loan. Three outside uncertainties are building at once: interest rates are rising, there is talk of new import restrictions in the export market, and the packaging supplier’s lead times have stretched from six weeks to ten.

The owner classifies each one:

• Interest rates: economic uncertainty. The business can still operate; margins on the expansion are affected. Response: hedge. Discuss rate options with the lender, and check the expansion still makes sense at higher borrowing costs, keeping the model consistent about inflation.
• Export restrictions: continuity uncertainty for 30% of output, in a market that remains attractive. Response: rebalance. Begin developing a second export market and a domestic channel for some of the same products, without abandoning the current market.
• Packaging supply: continuity uncertainty for the whole business. Response: hedge. Qualify a second supplier, including a domestic option, and hold more packaging stock while lead times are long.

The expansion is staged rather than committed in full:

Triggers are written down: if export orders fall by more than 30% for two consecutive months, shift product to the domestic channel; if packaging lead times exceed 12 weeks, move at least half of orders to the second supplier; if the cost of borrowing rises above the agreed level, defer stage 2. The owner also decides to hold enough cash to cover about eight weeks of fixed costs, which at roughly $30,000 a week means about $240,000, before committing to stage 2.

Six months later, the export restrictions are introduced in a milder form than feared, packaging lead times reach 13 weeks and the second supplier is activated, and domestic sales of the new range grow faster than expected. Stage 2 goes ahead, about four months later than originally planned, on a stronger footing. The forecast was wrong in several details. The plan held because it had options and agreed triggers.

How this applies to a small Australian business

Small businesses are exposed to outside shocks through customers, suppliers, lenders and regulation, often with limited buffers. Practical steps:

• List the outside assumptions behind your main plans.
• Separate economic uncertainty from threats to your ability to operate.
• Choose a response for each: hedge, salvage, rebalance or shift.
• Look for shared exposures across plans.
• Keep forecasts consistent about whether inflation is included.
• Watch financing conditions and keep some headroom.
• Value reversibility, and pay for it where uncertainty is high.
• Attach triggers to alternative plans.
• Sort decisions into commit now, stage and keep the option.
• Talk to your accountant, lender or adviser before significant changes in finance or structure.

The article on local or offshore manufacturing looks at supply decisions where continuity risk matters.

Signals worth watching

• Financing terms changing faster than plans are updated.
• Suppliers shortening quote validity or commitments.
• Forecasts revised repeatedly without any change in decisions.
• Political or regulatory changes threatening the ability to operate, not just margins.
• Cash becoming the main constraint on action.
• Several plans depending on the same supplier, market, lender or regulation.
• Contingency plans with no agreed trigger.
• Competitors repositioning while the business waits for certainty.

Common mistakes

• Revising forecasts without changing decisions.
• Treating continuity threats as ordinary cost changes.
• Waiting for certainty while options close.
• Treating all uncertainty as threat, missing the opportunities it creates.
• Mixing inflation assumptions in the same model.
• Ignoring shared exposures across plans.
• Writing contingency plans without triggers.

Frequently asked questions

How do we know if a threat is to continuity rather than economics? Ask whether the business could still operate if the threat occurred, perhaps at lower profit. If yes, it is economic. If an activity could not continue at all, it is a continuity threat.

Isn’t holding extra cash inefficient? In stable times, somewhat. In uncertain times, cash buys the ability to act when finance is harder to obtain. Decide how much is enough by estimating how many weeks of fixed costs the business would need to cover during a disruption.

How specific should triggers be? Specific enough that two people would agree whether the trigger has occurred: a number, a date or an observable event. Vague triggers produce debate rather than action.

What if we cannot afford a second supplier? Look for cheaper partial options: qualifying a backup without regular orders, holding more stock of critical items, or agreeing with a local supplier to help in an emergency.

Should small businesses use formal scenarios? Short ones are useful. Three brief descriptions of plausible futures, with your main decisions tested against each, can reveal where you need options or triggers.

Questions to ask

• Which outside uncertainty could make our current way of operating unworkable, not just less profitable?
• Which of our decisions are becoming harder to reverse as time passes?
• Which options are worth paying to keep open?
• What triggers would cause us to re-source, refinance, stage or stop?
• Do we have enough cash to act if finance tightens?
• Where are we waiting for certainty while waiting itself closes options?

Bringing it together

Outside uncertainty sometimes changes the numbers and sometimes changes the options. Tell the two apart, choose a response that matches the severity and the attractiveness of what is affected, keep inflation assumptions consistent, watch for financing chains and shared exposures, value reversibility and attach clear triggers to alternative plans. Sort decisions into those to make now, those to stage and those to keep open. Uncertainty is most dangerous when a business has only one plan. Resilience starts with having credible options in place before they are needed.

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Source: KEVOS notes, drawing on B. Laker and T. Roulet, “How Companies Can Adapt During Times of Political Uncertainty”, Harvard Business Review (2019), and teaching material on inflation, financing and enterprise environmental factors. Examples and figures in this article are illustrations. This article is general information, not financial advice.