Scenario Planning

Scenario Planning Definition

Scenario Planning is the prediction of future scenarios and gauging the effect of the scenario on the business. Therefore, it helps the management of a business to be prepared for business adversities that may arise due to changes in the current scenario. However, it is important to note that the data collection and formulation process is time-consuming and costly.

By incorporating a scenario planning strategy, a company can visualize future scenarios and be proactive instead of just reacting to situations as and when they arise. From developing future cash flows, and curating mitigation actions, this strategy is an integrated and coordinated approach to dealing with uncertainty; which might be the difference between a business and its competitors.

• Scenario planning involves predicting potential events and assessing their impact on a company. Doing so equips management to navigate business challenges that might arise due to changes in the current situation.
• It helps management better grasp potential future events and their implications for the company. This planning also includes developing contingency plans. 
• A manager's proficiency in scenario planning becomes evident when they adeptly manage unforeseen circumstances. Consequently, management can enhance its overall effectiveness within the company.

Scenario Planning Explained

Scenario planning a particular kind of planning which helps businesses to deal with future difficulties. Proper planning is done considering the upcoming scenarios, and businesses lay plans accordingly. All future investment by the company depends on scenario planning. Extreme scenarios are hard to predict; some assumptions can be used to save from the impact.

The scenario planning model shall help management develop an understanding of the possible scenarios in the future and their impact on the business. Strategies to deal with the scenario are part of the planning.

It should focus on a few most important scenarios as too many options complicate the process. There will be a huge cost involved in tackling all the scenarios effectively.

It is often misunderstood that this form of planning is only to avert difficult or bas situations. In reality, it also applies for scenarios that are good beyond the expectations of the company. For instance, a particular product goes viral on the internet and experiences 250% more orders than usual. The company must be prepared to meet the sudden rise in demand if they want to capitalize on the opportunity.

It is not just related to financial planning. In fact, it has a lot to do with projecting future cash flows, forecasting financial earnings, and mitigation plans. In short, it is an integrated approach to deal with the factors of uncertainty. Moreover, it is also used by government and international bodies to maintain an ideal scenario for international events and conventions.

Planning efficiently for good and bad situations allows companies to be proactive in circumstances out of their initial plan, instead of just reacting to situations and when they arise.

Types

Now that we have a brief understanding of the scenario planning strategy, let us now discuss its different types to delve deeper into this concept and its intricacies.

• Operational Scenarios: These are one of the most common types that a business will undertake internally. These scenarios refer to the immediate impact of a particular event. As a result, the situation or event demands the decision-makers to make short-term decisions or strategic calls to manage the situation.  
• Normative Scenarios: Under these types of situations, a lot of impetus is placed on the statement of goals rather than objective planning. It is solely based on how the company wants to operate in the short and long term. Individually, it might not be as efficient as other types of scenario planning but in combination with another type can make it a pretty strong choice.
• Quantitative Scenarios: This type of panning helps the management look at future situations from the best-case and worst-case scenarios. Therefore, it is efficient in allowing the user to make adjustments by changing variables. The most common use of this type of planning is during the creation of a budget.
• Strategic Management Scenarios: This type of planning has lesser consideration of the company per se and has more impetus on how the products or services are used. This is one of the most challenging forms of planning as it requires the decision-makers to have a comprehensive knowledge about their own company, the industry, and its competitors to formulate an efficient plan.

Process

There are multiple steps involved in the incorporation of a scenario planning model. Let us understand them from the step-by-step guide discussed below.

Step #1 - Predict the drivers of future

Several drivers may affect society. In the early 90's, technological growth started to boom. So like that, one should predict the next driver of the economy. It can be that a particular sector is about to boom, or a sector will lose its demand. Like this, an estimation needs to be done for the next driver in the economy.

Step #2 - Understanding the impact of drivers in your business

After predicting the future drivers, you will have to calculate the effect of that Driver on your business. Whether the next economic change will help you in your business or it will take a hit at your profit levels. Correct calculation of future drivers' impact is crucial in scenario planning.

Step #3 - Gauging the effect of Future Scenario

Carry out a calculation that will help you understand the possible future effects of the predicted economic scenario. The possibilities may start from Best to Worst. This will help you to understand the maximum gain you can pull from the scenario if everything goes as per planning and the maximum loss you may incur if things don’t go as per plan.

Step #4 - Always test unfavorable outcomes even in case of positive Future Scenario

Management should always be prepared for an unprecedented outcome, and plans should always be placed if the estimation of positive future outcomes fails. It should always include the positive and negative impacts of a scenario. There are businesses from the past that believed so much in the positive Future Outcome that they didn’t see the competition and adverse change in the economic condition.

Example

Let us understand the concept of scenario planning strategy with the help of a couple of examples. These examples shall give us a practical overview of the concept and its related factors.

Example #1

Company XYZ is an Automobile manufacturing company. They have been in the business for 20 years. They did scenario analysis five years back and realized that there would be a time when crude would not be available in the future. Therefore, they started planning for this scenario and bought a battery manufacturing company three years back. They are spending a lot of money on Research and Development to build a battery that will last 500 km with One Time Charge. The company estimated the change in the scenario for crude supply and planned its existence without crude.

Example #2

The 2020 Tokyo Olympics was in jeopardy when the COVID-19 pandemic hit the world. The International Olympic Committee stepped up their planning and security to brace for any untoward situations.

Their existing plans for the Olympics were drafted well before the event was due to ensure logistical and training-related arrangements could be made. However, since the pandemic was announced, they went above and beyond the existing plans of security and accommodation to being in bio bubbles, and social distancing mandates to athletes, coaches, and support staff to ensure smooth conduct of the ultimate global sporting event.

Advantages

Let us understand the advantages of adopting a scenario planning model in business and how it can change the way situations are handled through the explanation below.

• Scenario Planning helps management be prepared for business adversities that may occur due to shifts in the demand curve, economic condition, political condition, etc. So it helps management to draw a plan to fight negative circumstances in the future.
• Budgeting is the most important part of any project. If any project may be affected by any change in the future scenario, then the required return from the project will also change. So it also helps in budgeting decisions.
• Good planning helps to judge the performance of a manager. When a manager tackles the situation very comfortably, it shows the power of the manager’s scenario planning. So it helps a manager to improve their performance in the business.

Disadvantages

Despite the advantages mentioned above, there are a few factors that act as a disadvantage. Let us discuss the disadvantages of a scenario planning strategy through the points below.

• It estimates probable scenarios; it may or may not happen. So when a manager starts to depend too much on scenario planning and starts making all the decisions based on that, then a wrong estimation may hamper the business to a great extent.
• Scenario estimation should always change; the manager should perform proper updates on the scenario planning model at regular intervals.

Scenario Planning vs. Forecasting

Forecasting refers to the calculation of a company's profitability in the future based on the current and historical data available for the company. It is a quantitative method of judging the future. Therefore, forecasting helps a business estimate the company's goal if all the conditions remain stable.

Scenario analysis considers different scenarios that may occur in the future and will affect profitability. In scenario analysis, judgment is involved, and everything is based on estimation. Hence, scenario Analysis is more subjective.

Frequently Asked Questions (FAQs)

Recommended Articles

This has been a guide to Scenario Planning and its definition. Here we explain its examples, process, types, advantages, and compared it with forecasting. You may learn more about financing from the following articles –

• Scenario Manager in Excel
• Financial Modeling Software
• Cost Estimate
• Cost Drivers