Future always comes with a degree of uncertainty, especially in this time of political turmoil. How can you build a plan for your company if you are uncertain about the future?
Scenario planning was first developed by Royal Dutch/Shell to understand and prepare for an alternative version of the future including the first oil price shock. Because of this exercise the company was prepared and took great advantages of the opportunities and was able to respond to threats better than their competitors. And thus, scenario planning in a business setting was born!
These days scenario planning is a well-known discipline among strategic and operational planners who are looking to rediscover the power of the foresight, especially in the context of change, complexity and uncertainty!
Scenario planning is a great organisational tool, that helps business predict alternative versions of the future, each with its own logic and internal consistency. Generally, scenario planning is set up, so the business can envision their future better, it helps with estimating accurate budgets and increasing forecasting accuracy.
This simple process can be very cost effective to your business by helping you to minimise the risk of increased costs, risks and opportunities. If you are aware of what can happen, you can be prepared to deal with it better.
In financial modelling, this process is typically used to estimate changes in the value of a business or cash flow, especially when there are potentially favourable and unfavourable events that could impact the company in the future.
There are many benefits to scenario planning or scenario analysis.
- It gives clues to investors on your business position. It gives them a chance to look at the expected returns and risks when planning for future investments.
- It allows a business to concentrate on a proactive strategy moving forward, rather than reactive. This inherently allows a business to avoid or decrease the potential loss they would have experienced by being informed and where possible- aggressively preventative during worst-case scenarios.
- Another benefit of scenario planning is that you can use scenario analysis to assess investment prospects. It takes the best and worst possibilities into account so one can make an informed decision.
- Scenario analysis also makes a great tool to calculate the values of potential gains or losses from an investment. It gives measurable data to investors and business owners, so you can make up a better approach.
Needless to say, there are some drawbacks of scenario planning. It tends to be quite a demanding and time-consuming process and often requires high-level of expertise. Additionally, scenario planning is an extension of forecasting, which comes with its own disadvantage. A major problem is that predicting the future with an absolute accuracy, inherently, is impossible. However, there are some solutions to solving most of the scenario planning problems.
Scenario Planning Techniques
There is a lot to take in when you first start thinking about using scenario planning techniques to inform your business strategy.
- Start with outlining a scenario!
To start with a scenario planning you need start with outlining 3 basic scenarios. This is normally done by managers and executives to generate different future states of the business, the industry and the economy. These future states will form distinct scenarios that should include different assumptions about base variables, like product prices, customer metrics, operating costs, inflation and so on.
To begin running a proper scenario, outline the potential 3 scenarios with the basic understanding of the current situation. This will help you to inform your research further once you start “digging”.
- Use an analysis tool
Once you have your basic scenarios set out, use your environmental and industry analysis tools like PEST analysis, Porter’s five forces, threatcasting, SKEPTIC and anything else you can get your hands on. It is recommended to run a couple of these tools, so you have a well-rounded look at all aspects of a business.
- Identify trends
Using any of these (or all of these) techniques identify trends and potential turns in your industry. And then where possible try to extend this process to your supply chains. It might take longer, however identifying your supply chain market and any potential turmoil in their industry might have a very big impact on your business even if you don’t think it will affect you. For instance, if you are a software or digital business your internet speed and cost will affect the price of your product, and consequently, it will affect the product you provide.
- Condense your options
Generally, scenario analysis runs on about 3 to 5 scenarios. Looking at the above trends, you need to pick and choose the most impactful and the most likely scenarios that will happen. It is often suggested that you identify as many scenarios as possible and rate them in two ways – likelihood and impact to your business. This will enable you to identify the most important ones of them.
- Implement your financial and operational strategy
Now it is time to review your scenarios and implement them to your strategy. Use a what-if scenario to implement these steps. A what-if scenario is like an informal speculation about how given situation might affect the business (this is particularly important when looking at the finances) or how one can handle a given scenario.
Running a what-if analysis organically is possible, it can be difficult to optimise costs and required resources for a mature business, so it is recommended to use a specialised software. The right planning and forecasting software can help you to optimise the costs and resources required for your financial plan.
As any given scenario, plan or campaign in business, scenario analysis needs to be monitored. Especially one needs to keep monitoring any changes in the market during the period of your scenario implementation. This will help your business prepare for any further affects changes might have on your business.