Imagine that you're facing a really significant decision, which could fundamentally affect your personal life, or could determine the future of your business. Maybe you're thinking about "stretching your finances" to buy a bigger house. Or maybe you're thinking of launching a new product which you know could "cannibalize" existing sales.
Perhaps you've done the numbers, and these seem OK. But deep down, you dread what could go wrong. After all, no one has a foolproof vision of the future, and while you may have strong instincts as to how things may develop, any single projection of the future is clearly vulnerable to disruption by a range of different factors.
Scenario Analysis helps you bring these fears into the open and gives you a rational and professional framework for exploring them.
Using it, you can make decisions in the context of the different futures that may come to pass. The act of creating scenarios forces you to challenge your assumptions about the future. By shaping your plans and decisions based on the most likely scenarios, you can ensure that your decisions are sound even if circumstances change.
How to Use the Tool
In Scenario Analysis, the scenarios are stories about the way the world might turn out if certain trends continue and if certain conditions are met.
We offer a simple five-phase Scenario Analysis process, as follows:
1. Define the Problem
First, decide what you want to achieve, and think about the time horizon you want to look at. This will be driven by the scale of the plans and scenarios that you want to test.
Barry was starting to plan a new business that focused on helping corporate clients implement a popular financial management software package. He wanted the business to grow to a reasonable size over the next five years. With this in mind, he decided to use scenario thinking to look at what the future might hold over this period.
2. Gather Data
Next, identify the key factors, trends, and uncertainties that may affect the plan. If your plan is a large-scale one, you may find it helpful to do a PEST Analysis of the context in which it will be implemented to identify political, economic, socio-cultural, and technological factors that could impact it. Then, identify the key assumptions on which the plan depends.
Amongst others, Barry identified the following factors as important:
- The state of the economy (people don't buy much new software in a recession).
- The ongoing importance of new software in increasing clients' productivity.
- Whether the software package would maintain its market position.
- Whether he could recruit enough skilled implementation consultants.
3. Separate Certainties From Uncertainties
You may be confident in some of your assumptions, and you may be sure that certain trends will work through in a particular way. After challenging them appropriately, adopt these trends as your "certainties." Separate these from the "uncertainties" – trends that may or may not be important, and underlying factors that may or may not change. List these uncertainties in priority order, with the largest, most significant uncertainties at the top of the list.
Based on analysis of recent vacancy rates, Barry was confident that, provided he paid attention to recruitment, he could find a sufficient number of new employees. And seeing the new technologies shortly to be deployed by the software vendor, he was confident that clients would reap considerable efficiency gains by implementing the next versions of the software.
He was anxious, however, that a global software giant might enter the market and displace the current vendor. Furthermore, he'd seen plenty of implementation companies go bust in the previous recession.
4. Develop Scenarios
Now, starting with your top uncertainty, take a moderately good outcome and a moderately bad outcome, and develop a story of the future around each that fuses your certainties with the outcome you've chosen.
Then, do the same for your second most serious uncertainty.
Don't do too many scenarios in this step, or you may find yourself quickly hitting "diminishing returns."
Barry decided to prepare the following scenarios:
- "All's going well": The economy grows steadily over the five-year period with only minor slowdowns, and he's "backed the right horse." The software vendor consolidates itself in the market and moves into a position of market leadership.
- "Economic slowdown": Toward the end of the period, a commodity price shock pushes the economy into mild recession. While some new software implementations do go ahead, many clients decide to defer implementation until things pick up.
- "Intensifying competition": The global giant enters the market. While it takes time to get its products established, toward the end of the period, it is starting to squeeze the current supplier.
5. Use the Scenarios in Your Planning
You can now use the scenarios you came up with in your planning.
Having looked at the scenarios, Barry's aware that there's some risk to the business in the medium term.
In his business planning, he decides to gear the business to use a mix of full-time staff and short-term contractors so he can scale his business quickly, depending on the circumstances.
And he notes that he's going to have to monitor the activities of software companies entering the market so he can cross-train personnel if a new entrant starts to threaten the existing supplier.