What is it?
Scenario planning provides a structured method for managers to evaluate alternative views of what may happen in the future as an aid to strategic, operational, and financial planning. Scenario planning focuses largely on answering three questions:
- What could happen?
- What would be the impact on our strategies, plans and budgets?
- How should we respond?
Like many planning tools, such as strategic and tactical planning, scenario planning has its origins in the military. The adoption of scenario planning in the commercial world started in the oil and gas industry, notably at Royal Dutch Shell in the 1970s when it helped them to prepare for the oil crisis. The use of scenario planning by both businesses and public sector entities has expanded widely over the ensuing 40 years.
Four broad types of scenario questions include:
- Political: How will the expansion of the European Union change the political power of governments within the union?
- Economic: How will the rapid economic growth of China and India change global markets?
- Social: What are the implications of increasing obesity?
- Technological: What will be the impact of increasing adoption of smart phones on desktop and laptop computer usage?
Contingency planning is a risk mitigation process for developing back-up plans in anticipation of events that might disrupt ‘business as usual’. Business continuity planning is an expanded version of contingency planning that typically encompasses a more comprehensive and extended response plan for getting back to ‘business as usual’.
Common types of scenario planning include:
- Single variable sensitivity analysis – This is possibly the most common and the logical starting point for an organisation. Changing one variable at a time while holding others constant may not necessarily fully reflect complex interdependencies, but sensitivity analysis can be very valuable in understanding the potential impact of a key variable on business.
- Multi-variable narrative-based analysis - This form of analysis takes the form of a plausible theme that might play out in the economic, competitive, regulatory or social landscape, and considers the impact of multiple variables and uncertainties occurring jointly.
- Initiative-based scenario planning – Scenarios that layer various combinations of initiatives on top of a baseline enable an organisation to understand the incremental impact of growth or cost containment initiatives and set priorities within the overall strategic goals of the organisation.
Three typical approaches to defining scenarios are:
- Along a spectrum of possible outcomes, such as a plan with upside and downside possibilities
- A binary, either/or approach
- A matrix of two variables with relatively high degrees of uncertainty that yield four potential outcomes when plotted in the quadrants of a matrix.
Scenario Plan work approach
Source: David AJ Axson. Scenario planning: navigating through today's uncertain world. Journal of Accountancy. March 2011
What benefits does scenario planning provide?
Scenario planning provides improved insight about the choices, opportunities and implications that uncertainty presents. It brings better quality strategic plans, budgets and forecasts, and it enables a clearer understanding of the sensitivity of the key drivers of the business and the potential impact of future events.
Scenario planning also provides a foundation for explaining performance variations by reference back to drivers incorporated into the scenarios. It can be an early warning system for potential threats and opportunities for the business.
Questions to consider when implementing scenario planning
- What is the issue that we are trying to assess? Over what time horizon?
- What are the major external factors likely to impact on our scenarios?
- What are the key internal drivers that need to be addressed?
- Do we have the right data, technology, bandwidth and skills to develop and maintain scenarios?
|Actions to take / Dos||Actions to Avoid / Don'ts|
Navigating through today's uncertain world
The case of ElectricIQ, a software company that develops software for smart energy use, illustrates the application of scenario planning in practice (the name and details have been changed to maintain client confidentiality).
The company embarked on a scenario planning project to help understand the alternatives as an input to R&D, marketing and product development plans in anticipation of its expansion into the smart grid market for environmental energy management systems.
The team identified primary and secondary drivers of demand for renewable energy sources; analysed relevant underlying data; and developed four likely scenarios across the two axes of public policy and public opinion.
Using the scenarios as a baseline, ElectricIQ’s finance team recast the company’s five-year plan and annual budget under each scenario to assess the financial implications and identify key performance metrics that could provide the organisation with an early warning as to which scenario is actually playing out.
Related and similar practices