Most businesses run regular forecasts to predict cash flow, sales, capital requirements, and other financial metrics for the quarter or year to come. In the volatile world in which we live, these forecasts often fall short in preparing the business for unexpected outcomes. Scenario planning is a way to understand the ‘what-ifs’ left unexplored in traditional forecasts.
Let’s start with a definition of each concept. Investopedia defines forecasting as:
“a technique that uses historical data as inputs to make informed estimates that are predictive in determining the direction of future trends. Businesses utilise forecasting to determine how to allocate their budgets or plan for anticipated expenses for an upcoming period of time.”
The salient point here is that forecasting is primarily based on an analysis of historical data. It is often associated with quantitative modelling methods that use past performance to predict the future. However, some companies also use tools like customer surveys or expert polls (the Delphi model) for forecasting.
The Economist, meanwhile, describes scenario planning as:
“a structured way for organisations to think about the future. A group of executives sets out to develop a small number of scenarios—stories about how the future might unfold and how this might affect an issue that confronts them.”
As the definitions suggest, forecasting and scenario planning have different strengths and purposes. Traditional forecasting methods, while based on accurate data from the past, cannot anticipate how changes in technology, market conditions, customer behaviour and other factors might affect the business in the longer term.
MIT Sloan Management Review explains more: “In short, scenario planning attempts to capture the richness and range of possibilities, stimulating decision makers to consider changes they would otherwise ignore. At the same time, it organises those possibilities into narratives that are easier to grasp and use than great volumes of data.”
Perhaps the most well-known exponent of scenario planning in South Africa is Clem Sunter. He was part of a team at Anglo American in the 1980s that envisaged two scenarios for the country’s future: the ‘High Road’ of negotiation with the objective of creating a non-racial society or the ‘Low Road’ of retaining the status quo, leading towards economic stagnation, and possibly civil war.
Scenario planning is always a useful tool for executives, but it becomes even more so in uncertain times, like South Africa in the 1980s or the current coronavirus pandemic. Its utility is that it enables business leaders and teams to play out a range of different scenarios, think through the implications for their organisations, and create strategic responses.
There are many different approaches to scenario management, but most of them have the following five steps and processes in common:
- Identify the focus area—whether it’s what demand for your flagship product will look like in five years’ time, or how political developments in South Africa will affect your business as a whole.
- Identify the driving forces that affect the focus area—perhaps how changing consumer habits in COVID will affect demand for your product or the impact of regulation on your business.
- Identify the uncertainties—this could include factors like the speed of adoption of new technologies, fluctuations in pricing for your raw materials or the exchange rate, a merger of your two key competitors, a price reduction or the impact of new laws.
- Develop a handful of plausible scenarios—focus on both pessimistic and optimistic outcomes. A two-by-two matrix layout can be a helpful way to conceptualise this. Turn the scenarios into stories to bring them to life for business stakeholders. Look at Clem Sunter’s COVID-19 scenarios from earlier this year as an example:
- “Much Ado About Nothing” – a scenario where the Covid-19 virus is brushed off as another form of seasonal flu
- “The Camel’s Straw” – a scenario where the virus drives the global economy to the point of collapse
- “Spain Again” – a possible repeat of the Spanish flu which killed 3% to 5% of the world’s population
- “Tightrope” – a delicate balancing act between preserving lives and livelihoods
- Discuss the implications—finally, you and your team can talk through what these scenarios might mean for your business and how to respond.
Scenario planning pioneer, Peter Schwartz, says: “Scenarios can help people make better decisions—usually difficult decisions—that they would otherwise miss or deny.” It is a powerful way for businesses to identify potential opportunities and challenges, envision possible and desired futures, and make better decisions in an uncertain world.
[Photo by RODNAE Productions from Pexels]