Scenario planning

Scenario planning is a system for deriving and examining a set of distinctly different futures. The intent of scenario planning is to build a number of plausible future outcomes that vary from the most commonly-accepted scenario. A business can then create contingency plans for how to deal with each of these alternative futures. The outcome can be used within the budgeting process or to manage risk. Scenario planning is usually developed in a workshop setting by the senior managers of a business, sometimes in conjunction with outside experts who can contribute additional information about the industry, competitive pressures, and other factors that could lead to alternative scenarios.

Scenario planning can have the following positive benefits:

  • Once managers have discussed alternative futures, they are more likely to see the warning signs associated with these futures unfolding at a later date.
  • Managers can develop high-level plans for the actions to be taken if one of these scenarios becomes real.
  • Managers can face their own ingrained prejudices regarding why they consider certain outcomes to be more or less likely to occur.

The general process flow for scenario planning is as follows:

  1. Come to an agreement about the future time period over which the analysis will be conducted.
  2. Itemize the key factors driving competitive advantage in the industry.
  3. Identify the key uncertainties in the industry that could trigger significant changes.
  4. Discuss the likely ranges within which these uncertainties are likely to change within the designated future time period.
  5. Create a matrix of scenarios that is derived from the interaction of the identified uncertainties.
  6. Quantify the likely outcome of each scenario in this matrix.
  7. Develop a general strategy for how to deal with each scenario in the matrix.

The information developed in the most recent scenario planning session can be used as the basis for future planning sessions.

As an example, an airline's management team determines that a key uncertainty is the price of aviation fuel over the next ten years. The team agrees that the most likely price range is anywhere from a 25% boost to the doubling of prices over the analysis period. Any of these price points will result in significant price boosts for airline tickets, which will cut into customer demand. As a result, the team decides on a plan to gradually sell off all of the company's least-efficient jet engines and replace them with the most fuel-efficient models, while also experimenting with the use of a fuel surcharge.

Related Courses

Capital Budgeting