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Imagine that you're facing a really important decision. It's one that could fundamentally affect your personal life, or determine the future of your business.
You've crunched the numbers and looked at the data, and everything seems fine. But deep down, you dread what might go wrong.
No one has a foolproof vision of the future, and even if your instincts are good, the outcomes that you predict could be disrupted by a range of different factors. On the other hand, things may turn out far better than you expected!
In this article, we explore how Scenario Analysis can bring these hopes and fears into the open, give you a rational framework for exploring them, and enable you to make the best possible choices.
Types of Scenarios
Challenging your assumptions about the future, and basing your plans and decisions on the most likely outcomes, means that your decisions will more likely be sound, even if circumstances change.
But what are the most likely outcomes? Author and corporate strategist Peter Schwartz, one of the pioneers of scenario thinking, identified the following common scenarios:
- Evolution: all trends continue as expected. Things gently move toward a predictable end point.
- Revolution: a new, disruptive, factor fundamentally changes the situation.
- Cycles: what goes around comes around. Boom follows bust follows boom follows bust.
- Infinite Expansion: exciting trends continue. Think of the computer industry in the 1950s.
- Lone Ranger: the triumph of the lone hero against the forces of inertia.
- My Generation: changes in culture and demographics affect the situation.
From "The Art of the Long View" by Peter Schwartz. © 1991 Peter Schwartz. Published by Profile Books, 2003. Reproduced with permission of John Wiley & Sons Ltd.
Although Schwartz's scenarios may not all be relevant to your situation or your business, they provide a useful starting point for devising your own (see How to Use Scenario Analysis, below).
Scenario Analysis is often used for crisis planning. By imagining a range of negative scenarios, you can face your fears realistically and prepare for the worst.
But you can also apply Scenario Analysis in a positive way. Imagining a range of possible futures encourages curiosity and innovation within a framework that enables you to assess and minimize potential risks.
You can use Scenario Analysis for big decisions in your personal life, too. You might be thinking about stretching your finances to buy a bigger house, for example. Or you could use it in conjunction with a Personal SWOT Analysis to decide on a new career direction.
How to Use Scenario Analysis
To use Scenario Analysis, follow these five steps:
1. Define the Issue
First, decide what you want to achieve, or define the decision that you need to make. Then look at the timescale in which it will happen. This will be driven by the scale of the plan that you want to examine.
Example:
Barry is planning a new business that focuses on helping corporate clients to implement a popular financial management software package. He wants the business to grow to a certain size over the next five years, so he decides to use Scenario Analysis to explore what the future might hold in 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 useful to do a PEST Analysis of the Political, Economic, Socio-Cultural, and Technological context in which it will be implemented.
After carrying out your analysis, identify the key assumptions on which your plan depends.
Example:
For his software support business, Barry identifies the following factors as important:
- The state of the economy (people don't buy so much new software in a recession).
- The ongoing importance of new software in increasing clients' productivity.
- Whether the software package will maintain its market position.
- His ability to 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 continue in a predictable way.
However, bear in mind that in volatile economic conditions, certainties can be hard to come by. And try to avoid unconscious bias in favor of certain assumptions, by analyzing potential blindspots in your thinking.
When you've challenged 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.
Example:
Barry is confident that he can find enough suitable employees for his new business, based on his analysis of recent employment trends. And, after researching the latest updates to the software, he's confident that clients would reap considerable efficiency gains by using the new version.
He's anxious, however, that a new competitor will disrupt the market, and render his services obsolete. What's more, he saw 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 scenario around each that combines your certainties with the outcome you've chosen.
Then, do the same for your second most serious uncertainty. There's some creative thinking involved in this step, and you need to be able to sketch out a likely chain of cause and effect.
Don't do too many scenarios in this step, or you may find yourself quickly hitting "diminishing returns."
Example:
Barry decides 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: a new competitor enters the market. Although it takes time to get its products established, toward the end of the period, it starts to squeeze the current software supplier.
5. Use the Scenarios in Your Planning
You can now use the scenarios you came up with as part of your planning, making the decisions you need to make with an eye on the most likely risks and rewards.
Infographic
See our infographic, The Secrets of Successful Scenario Planning.
Example:
Having looked at his scenarios, Barry's aware that there's some risk to the business in the medium term.
In his business planning, he decides to use a mix of full-time staff and short-term contractors so that he can scale his business quickly, depending on the circumstances. This gives his business flexibility and resilience.
And he notes that he's going to have to monitor the activities of software companies entering the market, so that he can cross-train personnel if a new entrant starts to threaten the existing supplier.
Tip:
When you identify trends, take care to base your assessment on evidence rather than supposition. And make sure that the trends you identify have secure foundations. Many trends are weakened by wider economic and social factors.
Key Points
Scenario Analysis can help you to make better decisions, or to plan your business strategy, by challenging your assumptions about the future.
Exploring a range of alternative scenarios allows you to identify potential risks and plan how you will counteract or mitigate their impact.
To use the tool, follow these five steps:
- Define the issue.
- Gather data.
- Separate certainties from uncertainties.
- Develop scenarios.
- Use the scenarios in your planning.
