Preparing for the future: The power of scenario planning

One of the biggest business risks is information uncertainty – organizations don’t know what they don’t know. So how can executive teams make confident decisions and move forward in a volatile, uncertain, complex, and ambiguous (VUCA) world? One way is through scenario planning.

Scenario planning involves generating and analyzing potential future scenarios, including simulating the effects of intricate changes on the organization and conducting rigorous assessments of alternative courses of action. It provides a structured approach to view different ways the future may unfold based on current trends and assumptions. Using a scenario planning software, executive teams can make decisions based on various possibilities to stay adaptable and drive growth.

The future is probabilistic. Scenario planning empowers organizations to prepare for several potential outcomes based on what they think might happen or what they will make happen. It also uncovers opportunities and risks, tests the robustness of their strategies, and improves decisiveness amid uncertainty.

Economic Policy Uncertainty Index for the United States. This series calculates an index based on the proportion of newspaper stories that discuss uncertainty, changes to tax codes, and disagreement among forecasters.

Equity Market-related Economic Uncertainty Index. This series relates more to market sentiment by looking at newspaper stories mentioning the economy, stock markets, and uncertainty specifically.

When creating a traditional forecast, budget, or business case, finance teams acknowledge the limitations of their perspective. A single estimate cannot encompass all potential outcomes, so certain conditions are applied to the forecast, such as reduced revenue, increased expenses, or a larger discount rate. Scenario planning complements forecasting because it is based on the principle that multiple outcomes are feasible, encouraging teams to think beyond their assumptions and expand their perspectives.

Scenario planning often starts with the most recent forecast and then adjusts the scope. The forecast can be the most probable scenario or an agreed upon plan. Scenario planning takes the forecast and changes the assumptions by applying “what ifs.” For example:

Overall, scenario planning is a more comprehensive and adaptable approach to planning than traditional forecasting because it embraces the uncertainty and complexity of the future.

Scenario planning helps organizations build resilience, adaptability, and strategic agility, which are critical for navigating disruptions such as supply chain bottlenecks, inflation, and economic downturns. Some benefits include:

Where does the organization stand right now and under what market conditions? What are the key trends, forces, and uncertainties that could shape the future business environment? These may include economic, social, technological, environmental, and political factors. This is often accomplished by identifying and analyzing critical strengths (strong balance sheet, high market share, or strong backlog) as well as weaknesses (product cost inefficiencies, litigation, or an underfunded marketing campaign) with a strengths, weaknesses, opportunity, and threats (SWOT) analysis.

This is where the “what ifs” come into play. Develop three to seven plausible and diverse scenarios that represent different possible futures and include assumptions around both external and internal changes. These scenarios should be internally consistent, logically coherent, and cover a range of possible outcomes. External changes that may affect the organization include government actions, sudden fluctuations in demand, and actions by competitors or new entrants. Internal changes can include human resources (HR) staffing levels, capital funding and allocation, and launching or sunsetting product lines.

A strength can quickly turn into a challenge. For example, many retailers believed their store footprint at major malls was a strength until the COVID-19 pandemic fundamentally changed consumer behaviors.

Analyze each scenario in detail, assessing its potential impact on the organization and identifying the associated risks and opportunities. Then determine the strategic direction the business should take for each scenario. For example, if a competitor launches a superior product and the organization is unable to respond with a comparable offering for at least six months, how should teams respond? One option is accepting short-term losses and expecting to gain customers back when they are ready. Other options may include pulling out of the market completely, or attacking with a marketing campaign that identifies their product’s strengths and the competitor’s shortcomings.

This stage is where organizations need to spend the most time, and it can also be the most frustrating. It is important to not only focus on the most likely scenarios, but also think about black swan event scenarios – and not all of them should be negative. How can teams respond if their YouTube video goes viral, spiking the demand for one product? Would they be able to meet demand? If not, would the demand be lost? Settle on a reasonable number of scenarios so it will be manageable while still being useful.

Create a strategy and plan for each scenario. A plan does not have to be a full-blown business plan with charts, diagrams, and financial projections, but it should address the risks and opportunities identified in each scenario. These strategies and plans should be adaptable and designed to enable the organization to respond quickly and effectively to changing circumstances.

Each plan can be a short, bulleted list of steps to take if the scenario occurs. It is important not to get too specific at this stage. Business is dynamic, and change can happen rapidly. In the moment, teams must take action – not everything can, or should, be planned out. The goal is to create a framework in which to consider how to respond to a particular situation.

Many people choose not to act when faced with a difficult choice, often to minimize harm or avoid accountability. In business, the worst decision is almost always making no decision at all, especially in a VUCA world. Identifying the key triggers that would warrant the planned action is critical in fighting inaction. For example, if a busy season comes in more than X% below expectations, then what needs to happen? It is natural to decide to make it up in the next quarter, but will that happen? If so, how?

Remember, hope is not a strategy. Strategy is acting based on a series of assumptions within a framework that has already been thought through. Strategy is hard work, and that is why effective scenario planning helps teams formulate the best strategies before they happen – so they are prepared to act.

Monitor the environment for changes and update scenarios, strategies, and plans as necessary. The scenario planning process is iterative and may involve revisiting earlier steps as new information or insights become available. The process should also involve input from stakeholders across the organization and beyond, including experts, customers, and employees, to ensure that a wide range of perspectives are considered.

Scenario planning can be extraordinarily time consuming, and the benefits may not be instantaneous. However, the process does not have to be performed monthly. Quarterly, or even twice per year, may be ideal for some organizations. Using a third party to review the existing planning model and manage the process may be beneficial, as most finance teams have limited capacity beyond other reporting requirements and projects. Teams will reap the benefits of scenario planning the more frequently it is performed for several reasons, including in the following areas:

Named after the Monte Carlo Casino in Monaco because of the inherent randomness of games such as roulette, the Monte Carlo simulation is a mathematical method for calculating the probability of multiple potential outcomes through repeated random sampling.

We are well prepared for further growth, increasing data volumes, and new business challenges.
Director of Finance, Nölle + Nordhorn GmbH

Effective scenario planning requires a rigorous and systematic approach, as well as a willingness to challenge assumptions and consider a range of perspectives. Creating comparisons between different assumptions and scenarios requires an enormous amount of time, preparation, and manipulation. Teams often spend time duplicating dozens of spreadsheets just to simulate one scenario. Machine learning, predictive forecasting, and other AI tools are replacing traditional scenario planning methods, enabling always-on forecasting and scenarios to drive actionable insights and confident decision-making – regardless of uncertainty.

The Jedox AIssisted™ Planning solution delivers driver-based forecasts that predict what-if scenarios and produces three forecasts for each new scenario. This frees up finance teams to focus on higher-value tasks. When high-performing teams have the tools they need to deliver adaptable plans, they can achieve the decisiveness, confidence, and performance they need to shape the future.

With Jedox AIsissted™ Planning, we can plan at a level of detail that was not possible before.
Director of Performance Controlling, Mistui Chemicals Europe GmbH