Step 1: PEST, SWOT and Five Forces: Scanning the Current Position and Environment    A board is in need of  a base level to start with, to provide a benchmark for the current organization. Questions to be asked are:

• What are the key relevant characteristics of the pension fund? (i.e. size, solvency, cost level, level of investment excellence, etc.)
• What are the current strengths and weaknesses of the pension fund?
• What will drive change in the next 5–10 years? Which of these changes or combinations of changes could be perceived as stable, and which as turbulent?
• Are there signs of new changes emerging, and how should they be characterized?

The most commonly used tools to support trustees are the PEST analysis, the Five Forces Model, and the SWOT Analysis.

PEST Analysis    PEST (Political, Economic, Sociocultural, Technological) represents a point of entry for a more extensive analysis. PEST can be used to establish an overview or the big picture of the current situation, and to set the course for further investigation. The PEST analysis provides the framework within which the board can pursue its purpose, striking the balance that ensures its continuing existence. The method involves a breakdown of the environment into six segments:

Political	Political issues and forces.
Participant	Understanding your current and future customers.
Environmental	Environmental, habitat and sustainability issues.
Technological	Scientific and technological issues.
Social	Social issues, such as individualism or lack of trust.
Economic	Economic issues such as long bond yields or an inflationary context.

The significance of the individual segments may differ according to the focus and perspectives of the particular pension fund. As an example, Exhibit B.2 shows the PEST Analysis performed by the Tyne and Wear Pension Fund, where the focus lies on economic and political factors.

Five Forces Analysis    Porter's five forces analysis is a framework for analyzing the level of competition within an industry and business strategy development. It is created for the analysis of industries that are for-profit, whereas most pension funds are not. At first sight, being a captive institution may seem like an advantage, but in fact, it is not. The absence of short-term market forces actually means that the fund has to put more effort into understanding whether it is really efficient and fit for purpose. If not, sooner or later its existence will be threatened.

Porter's five forces determine the competitive intensity and therefore the attractiveness of an industry. Attractiveness in this context refers to the overall industry profitability. An “unattractive” industry is one in which the combination of these five forces acts to drive down overall profitability or success. A very unattractive industry would be one approaching “pure competition,” in which available profits for all firms are driven down to a minimum normal profit.

The five forces also affect pension funds' ability to serve their customers and generate sustainable income and/or make a profit. A change in any of the forces normally requires a business unit to reassess the marketplace given the overall change in industry information. Porter's five forces include three forces from “horizontal” competition: the threat of substitute products or services, the threat of established rivals, and the threat of new entrants; and two forces from “vertical” competition: the bargaining power of suppliers and the bargaining power of customers Exhibit B.3.

• Competition in the industry. The importance of this force depends on the number of competitors and their ability to threaten a company. The larger the number of competitors, along with the number of equivalent products and services they offer, the weaker the power of an individual company. Suppliers and buyers can seek out a company's competitor if they are cannot get a good deal.
• Potential new entrants into an industry. A company's power is also affected by the force of new entrants into its market. The less money and time it takes for a competitor to enter a company's market and become an effective competitor, the more easily a company's position may be significantly weakened.
• Power of suppliers. This force reflects how easily suppliers can drive up the price of goods and services. It is determined by the number of suppliers of a good or service, how unique these are, and how much it would cost a company to switch from one supplier to another. The fewer suppliers there are and the more a company depends on a single supplier, the more power the supplier holds.
• Power of customers. This specifically deals with the ability customers have to drive prices down. It is determined by how many buyers, or customers, a company has, how significant each customer is, and how much it would cost a customer to switch from one company to another. The smaller and more powerful a client base, the more power it holds.
• Threat of substitutes. Competitor substitutions that can be used instead of a company's products or services pose a threat. For example, if customers rely on a company to provide a tool or service that can be substituted by another tool or service or by performing the task manually, and this substitution is fairly easy and inexpensive, a company's power can be weakened.

Step 2: Structuring and Foresight    The board now has a clear understanding of the fund's characteristics, its strengths, weaknesses, and internal and external development. The next challenge is to structure this knowledge and use it to shape strategy development for the future. In the process, the board “memorizes” the future, developing scenarios to visualize where it is heading.³

Unless the board operates in a perfect monopoly, the future is inherently uncertain. This makes it necessary to develop many different “futures” and assess how they would affect achieving the fund's goals and how to allow for this within policies. External forces will have a strong influence on the way the mission takes shape in the current and future environment. Where a Defined Benefit system was once the logical solution in European and American pension systems, pension systems in many parts of the world are changing nowadays to collective or individual Defined Contribution (DC) systems. This development has been accelerated by structural trends, such as changing accounting rules, the effects of increasing longevity, increased individualism, changing technology, and the effects of climate change on financial markets. Scenario-based thinking would have allowed boards to pick up on these trends at an early stage. So, the challenge for the board is to identify developments early on, and internalize them by turning them into “uneasy” questions:

• Are we really providing a good pension for our beneficiaries given the premium they pay and the expectations they have?
• What is the measure of success that our key stakeholders will apply to us given the context and will we deliver?
• Is there a role, and if so what, for climate change in our investment policy?

These “foresight” questions are often skipped or overlooked by the board, pressured by time to focus on day-to-day decision-making. Board members should be able to look stakeholders in the eye—both individually and collectively—and say that they have explored all relevant alternatives and possible futures to ensure the objectives can be met as well as possible. The board cannot outsource these questions, although it can be assisted by external parties.

With the use of scenarios, pension funds can anticipate and respond more rapidly to new developments, opportunities, and risks. Scenarios can convey a picture of how the future could unfold and can provide a choice of different, very varied future images. None of these scenarios is good or bad as such. The most important point is that they are plausible and that the board and/or the investment committee can translate them into a relevant policy (investment policy and risk management). Working with scenarios helps both investors and decision makers think outside the existing framework.⁴ The theory behind this is that if decision makers are aware of, and prepared for, a number of scenarios, the organization can adapt to any unforeseen or unexpected changes more effectively and rapidly.

Scenarios are inherently different to regular plans and annual budgeting. Plans can extrapolate developments for a number of years and lay down the most logical measures. Thinking in terms of scenarios takes such an overview as the base and develops alternative directions. An abiding tool for the development of scenarios is knowledge of the variables that impact on a pension fund. High and low growth in the financial markets and high or low economic growth and/or inflation are among the most important economic variables.

Many funds, therefore, work with a limited number of scenarios. This could include deflation (meaning pension obligations can't be paid), inflation or stagflation (eroding purchasing power), and also a recovery scenario. An asset allocation is then worked out for each scenario. Economic indicators can be linked to the scenarios so that the investment committee can assess whether the assumptions on which the fund policy is based (the basic scenario) seem to be changing. This allows the pension fund to anticipate such changes at an early stage. This is not the same as forecasting, but rather a matter of perceiving a situation at an early stage. Economic scenarios can be used to elaborate the consequences if a decision does not work out. This is also referred to as the “regret” criterion Exhibit B.4.

Scenarios are not predictions. Forecasts, projections, and extrapolations only work effectively as the basis for strategic planning in a stable world, something from which we are all far removed. Pierre Wack, the founding father of strategic planning at Shell, puts it as follows:

Forecasts are not always wrong; more often than not, they can be reasonably accurate. And that makes them so dangerous. They are usually constructed on the assumption that tomorrow's world will be much like today's […] forecasts will fail when they are needed most: in anticipating major shifts in the business environment that make whole strategies obsolete. […] The better approach, I believe, is to accept uncertainty, try to understand it, and make it part of our reasoning.

Economic scenarios can be ascribed levels of probability in order to base policy on them. However, ascribing probability to scenarios is a notoriously difficult exercise and suffers from psychological biases. Scenarios that most resemble the recent past are often ascribed the greatest probability; if emotions play a role, the impact is estimated to be higher, and there is the risk of new information being searched for and used to bolster existing ideas.

In most scenario-planning exercises, the scenarios are developed within the pension fund, either by the board or by investment committee. As a starting point, the most “known” scenarios are likely to be elaborated. This limits effectiveness with respect to decision-making, and calls for divergent thinking at an early stage. This can be illustrated by the streetlamp problem. When people have lost their car keys in the street, they intuitively look for them in the light of the streetlamp even though this only covers a small area of the street. In other words, new information and insights can be related to scenarios already developed and used to confirm choices made previously. One method of combating this potential bias is to invite outsiders who represent minority viewpoints on the future to participate. This form of deliberate diversity of opinions will reduce “frame blindness” within an organization. An alternative to organizing a structured debate is to draw up a limited number of scenarios in sub-groups and allow them to be critically discussed by the groups; this will put the spotlight on assumptions, justification and correlations.

Step 3: Vision and Goal Formulation    In Step 3, the Vision and Goals are formulated on a 5–10 year horizon. What is especially characteristic of the pension fund? How does the board view the future, and is this reflected in or consistent with the defined purpose and mission? We mentioned this earlier in this Appendix. Given where you are, the external forces, your purpose and mission, and your values, where do you want to be 5–10 years from now? Which weaknesses must be addressed? Do you aspire to become more excellent, or more efficient, or more sustainable than you currently are? If you define this clearly and put it into words, you have your vision. Remember that it should be a realistic vision, but that a certain amount of stretching of the mind in general gives all the parties involved a lot of energy.

Step 4: Strategic Plan    Once you know where you are (Step 1) and where you want to go (Step 3) you can make a plan on how to get there: this is the plan. A strategic plan typically has a five-year horizon, and will most often be subdivided in three stages of one to two years. The strategic plan should inform the annual planning cycle, so that you can take concrete annual steps in implementing the plan. The plan should, as far as possible, be formulated in SMART (Specific, Measurable, Achievable, Realistic and Time-bound) form.

Step 5: Implementation    Knowledge gained from the analysis is translated into concrete organizational goals, measures, projects, or programs. What concrete measures are to be deployed? How can one become even better prepared for the future?