Around this time last year your organization was kicking off its 2020 forecasting exercises. Some businesses were feeling the impacts from the tenuous trade war with China, but for the most part there was a lot to be optimistic about. Your business most likely finished 2019 with strong performance, and your forecasts showed that success continuing into 2020. By the time you were reporting on January’s performance, there were rumblings of a pandemic in China that had spread to Italy, but there wasn’t much to worry about in the United States. Besides, the numbers for January still looked good.
Then everything went sideways. COVID-19 hit the United States. State and local government was forced to shut down much of society in order to control the spread. Your 2020 forecast was suddenly obsolete barely two months into the year. Many businesses like yours struggled with how to respond and adapt. Valued employees were laid off, expenses were cut to the bone, and the hope was that this would all be over quickly so things could get back to “normal”.
Yet many companies were able to pivot, innovate, and remain profitable over the last six months because they were prepared. Many of them had already given up on the traditional form of forecasting that is based on the assumptions that the future will be like the past. They had already realized that markets move very quickly and there are multiple factors that can have significant impacts on future performance. They relied on scenario analysis to create a flexible forecast that could be adjusted on the fly to account for changes that were happening in the present.
Today all businesses are dealing with an unprecedented level of uncertainty. This calls for a new model of planning and forecasting to ensure your business can meet the challenges you will face in the coming months and years.
Scenarios as a Planning Tool
Developing scenarios for future performance is a task that consumes significantly more time than just plugging numbers into a spreadsheet and calling it a forecast. But the benefit of this investment is that the forecast is more than just a baseline for measuring future performance, it can become the foundation of your strategic and tactical planning for the upcoming period. This approach allows the organization to develop metrics and benchmarks that can be adjusted in real time as uncertainties become realities.
My experience using scenario analysis as a planning tool has shown that taking a structured approach with a strong facilitator is the key to efficiently preparing a high-quality scenario-based forecast. Generally speaking, the following framework has proven most effective with my clients.
- Start with a PEST analysis to identify the critical factors that will impact performance in the upcoming period.
- Identify the potential events that could impact these critical factors in the upcoming period. While the events could be improbable, they should still be plausible. For instance, before this year a global pandemic like COVID-19 was considered by most to be improbable, but it was certainly plausible based on the mounting evidence provided by experts.
- Seek the input of internal and external subject matter experts on each of the events you have identified. At this stage, you are looking for the potential impacts of these events.
- Research historical outcomes of the events / impacts that have been identified. You want to pay attention to the reasons that past events unfolded like they did and determine if similar conditions still exist.
- Develop your scenarios based on the potential ways in which these events could unfold. Generally speaking, you want two or three outcomes for each event (i.e., things get worse, things stay the same, things get better).
- Determine the impact on your forecast for each event and its outcomes. I like to use a component method so that I can adjust different assumptions at both the event and the outcomes level as necessary.
- Review your analysis with your subject matter experts and incorporate their feedback.
- Document your scenarios. This could be done in a visual format (similar to the example below), as a narrative, or in some other form that allows the organization to consider the results in decision making.
I have found that the most compelling use of scenarios for planning and forecasting to frame the scenarios as stories for your business using short narratives, then support the narratives of quantifiable and qualitative data. Now that you have your completed scenarios, you can apply them to your forecast to determine strategic initiatives and contingent planning.
Scenario Planning in Action
Below is the output of the analysis of one scenario for one of my current clients, a single-location retail store. One of the events considered in this client’s analysis is the impact on sales if there is a vaccine that is available before the end of the year with the assumption that a vaccine would help consumers feel more comfortable shopping brick and mortar stores this upcoming holiday season.
Based on the experts we have spoken to and the research we conducted, there is a ten percent probability of a vaccine being available before the holiday shopping season. If there is no vaccine available, we are currently estimating that there is a 75 percent probability that sales will decrease, and a 65 percent probability that the decrease will be about five percent of sales. That means, based on the current scenarios, there is 43.88% probability that sales this year will decrease by five percent (90% * 75% * 65% = 43.88%). In this scenario it is pretty much assumed that there will be no vaccine, store traffic will be down, and sales will fall. Seeing these numbers gave the business owner the push he needed to explore other options for holiday sales this year.
But, what happens next month if results from current trials yield promising results and the FDA agrees to fast-track a vaccine? We reassess our analysis and maybe we determine that there is 60 percent probability for a vaccine, but all other factors stay the same.
Now our analysis is telling us that there is still a 19.5 percent probability that sales will decrease five percent if there is no vaccine, but if there is a vaccine there is an 18.15 percent probability that sales will increase five percent and a 15.60 percent probability that sales will decrease five percent. In this situation, the probabilities across the different outcomes have flattened, which means more uncertainty about how the store will perform. We mitigate this uncertainty by reassessing the impact of other scenarios on overall business performance, and possibly modeling new scenarios as well (i.e., moving to a hybrid retail-online model, preparing for COVID-friendly shopping experiences, and so on).
From this example you can see two important aspects of scenario analysis that make the process far superior to traditional forecasting methods. First, scenario analysis looks to the future instead of relying on the past. Markets move fast, and the only normal in business is that there is no normal. Even without an economic crisis, if you are looking at last year’s performance to figure out next year’s performance, you are going to fail every time. Scenario analysis is not intended to predict the future, but it does help you quantify and qualify uncertainty so that it can be properly addressed.
Second, scenario analysis is a robust tool that offers you the ability to update your forecast so that it stays fresh as your business environment changes. Forecasts should not be a set-and-forget endeavor. Forecasts are decision making tools, but if the forecast does not reflect the current state of affairs then it has no value.
Scenario analysis is not intended to predict the future for your organization. The futurist Peter Schwartz’s Art of the Long View is essential reading on the topic of scenario planning, and in it he illustrated the power of scenario planning in a quote from historian Barbara Tuchman: “Man will not believe what does not fit in with their plans or suit their prearrangements.” Scenario analysis emphasises the fact that our plans have a degree of inherent uncertainty, thus decision makers will be primed to accept unexpected changes to their plans and have the agility to accommodate these changes when they occur.