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Scenario Planning Techniques Are More Important Than Ever

Years ago I believed that scenario planning techniques were too complicated and time consuming for many small businesses to focus on.

I saw scenario planning as a strategic planning tool for big companies but small and medium sized businesses were better off-putting together their plan on most likely assumptions and then get on with implementing it.

I was wrong.

While scenario planning still won’t be right for many smaller businesses – what they get out from the exercise won’t be worth the time and effort they put in – for some, using effective scenario planning techniques is the only was to make sure that the strategy is robust enough to cope with alternative future realities.

What Is Scenario Planning?

Scenario planning first appeared in American military planning after World War 2  to understand the possible outcomes.

In business scenario planning techniques were developed in Royal Dutch/Shell to interpret, understand and prepare for alternative versions of the future including the first OPEC oil price shock in 1973. Because the company had thought about what could happen in detail, it was much more prepared to take advantage of opportunities and respond to threats than its competitors (SWOT Analysis).

Scenario planning is a discipline for rediscovering the original entrepreneurial power of creative foresight in contexts of accelerated change, greater complexity, and genuine uncertainty.

Pierre Wack, Royal Dutch/Shell, 1984

Just to be clear, scenario planning isn’t about making a single prediction of the future but about creating alternative realistic versions of the future, each with its own logic and internal consistency.

The image above shows the movement in the price of oil and the expectations for the future oil price which highlights the inherent uncertainty in some situations.

You can see that predictions are strongly influenced by the  recent past:

  • when oil prices were stable, they were expected to stay stable
  • when oil prices were rising, they were expected to continue to rise
  • when oil prices were falling, they were expected to continue to fall

But all the predictions were wrong and in a business where the price of oil determines whether oil wells are profitable or loss making and where exploration costs are large with high risks of failure, viewing strategy under different oil price scenarios made a lot of sense.

Scenario Planning For Small & Medium Sized Businesses Going Forward

I realise that you are almost certainly not in the oil industry but recent years have emphasised the importance of considering the external business environment in more detail.

The Uncertain World Environment

Using scenario planning techniques is a way to make sense of what has been happening and what may happen as a result of shocks to the worldwide economic systems:

  • The rise of the BRIC countries in world trade – Brazil, Russia, India and China – and their acquisitions of landmark businesses. For example in the UK, manufacturing giants like British Steel is now part of the Tata group in India or MG Rover is owned by a Chinese group.
  • The development of the Internet, its impact on access to information, the development of long tail global promotions and the impact of retail buying moving from the High Street to online.
  • The credit crunch in 2007 and crisis in 2008 which saw the UK government step in and save RBS, Lloyds TSB and Northern Rock.
  • The recession of 2008/9 and despite huge fiscal and monetary stimuli, the failure to pull out of the recession strongly
  • The national debt crises of 2010/11 in Greece, Ireland and Portugal that risk spreading to other European countries
  • The national government austerity measures necessary to bring annual deficits under control.
  • The Arab spring uprisings and political changes in much of North Africa and the Middle East
  • Rising inflation in commodity prices, fuel and food which risk causing civil unrest as markets have been pumped with cash from quantitative easing. In August in the UK we saw nights of riots and looting in London, Birmingham, Manchester and other towns and cities.

As I write this in September 2011, the following could happen

  • The world economy experiences a double dip as austerity measures and reductions in consumer confidence cause demand to weaken further.
  • The Euro-zone could collapse, splitting Europe into two (strong and weak economies) or even back into the individual countries. Alternatively the economic pressures could force progress for fiscal and political union to accelerate rapidly.
  • Debt defaults from Greece and potentially Ireland, Portugal and other at risk European countries will create a huge crisis in the European banking system which will make 2008 look like a picnic in the park. The knock-on effects will be worldwide because financial systems are so interlinked.
  • Inflation and unemployment both shoot up or perhaps even worse, deflation and high unemployment
  • Civil unrest becomes widespread

Business will still go on but not as normal.

Trade is essential since none of us as families, as local regions and as countries are self sufficient.

The Simple Choice

You can either put your head in the sand and think that it’s all too difficult, you can’#t control any of it and you’ll react as things happen.

Or you can start thinking about the alternative futures and plan how you can make sure your business is positioned well in all likely scenarios.

How To Put Scenario Planning Techniques Into Practice

Step 1 – form your scenario planning team. You’ll find it easier to do with other people than on your own because one idea sparks another and where there are heated debates, you have a warning that there may be a further split in scenarios.

Step 2 – Gain a shared understanding of the current situation. The future is uncertain but you want to be clear about the present. Agree how far you want to look into the future. For most businesses I’d think in terms of two to three years but some might need to look ten years or more ahead.

Step 3 – Use the common environmental and industry analysis tools like PEST Analysis, Porter’s Five Forces and SKEPTIC to look back to look forward. Identify the trends and any recent or potential turns. As the graph of the oil prices above shows, trends can continue, they can stop or reverse.

Step 4 – Identify either/or situations which will form the basis for your scenario planning. For example it looks like the Euro can’t continue as it is and it will either break up or force political union. The impact of either will create very different scenarios for anyone who trades with Europe.

Step 5 – prune your options by rating each in terms of potential impact and likelihood. Rate each dimension in terms of high, medium and low. One big problem with scenario thinking is that you can create an overwhelming number of options and you lose yourself in all the different possibilities. That goes against the objective of scenario planning which is to provide more clarity to your strategy.

If you don’t find the high, medium, low to give you sufficient clarity, go back and rate the lows as 1 to 3, the mediums as 4 to 6 and the highs as 7 to 10. Some strategists favour going straight in from 1 to 10 but I find it much easier to filter through the high, medium and low first, group like items together and then further refine the ratings.

Go through and eliminate the easy ones – the lower impact or lower likelihood options and steadily move up so you’re left with three main categories to focus:

  • high impact, high probability
  • high impact, medium probability
  • medium impact, high probability

If all the major future changes are highly probable, you have the option of reverting back to the standard strategic planning techniques since you view the future with a lot of certainty.

If you have different high impact, medium probability changes, then you need to continue your scenario planning exercise.

Step 6 – sketch out possible scenarios as combinations of the big issues – try to limit to two or three factors since the matrix of possibilities again grows quickly.

e.g. a 2 x 2 will generate four combinations, 3 x 3 will generate nine.

Again look to eliminate based on lower impact and probability because I want you to focus on three or four scenarios to take forward for more detailed analysis.

e.g. for a luxury goods company which sold high volumes into Europe and had European competitors I’d want to focus my scenario thinking on:

  • Euro-zone collapse, banking crisis, five to ten year global depression
  • Long term European uncertainty, banking crisis, one to three year global depression
  • United States of Europe, no banking crisis, one year global recession
  • United States of Europe, no banking crisis, no recession

Step 7 – Flesh out the scenarios into logically consistent stories falling back on PEST analysis and the Five Forces. Think through the impact of the different scenarios on:

  • Directly on your business, your employees and suppliers
  • On your customers and their customers further upstream in the value chain
  • On your competitors and their employees and suppliers

Step 8 – Look at the likely transition from here to there and the likely events and warning signs that will tell you which way the future looks to be moving. It’s always much easier to look backwards and see the route than it is to look forward.

Step 9 – If you already have a strategic plan for the next few years, look at it under your different scenarios to see how robust it is. Where does the plan come under pressure? Where are the fundamental assumptions open to challenge?

Step 10 – Identify how you can change your strategy to work under the different scenarios. What strategic options are there that make sense under the different views of the future? What strategic options make sense regardless of what happens?

You’ll see three types of options emerge:

  1. Those that you need to get on and do because they make the business stronger and more competitive under each scenario.
  2. Those that make sense once it is clear that something is happening and which can wait until you get clear signals from the market.
  3. Those that create a winning strategy under one scenario but not the others and may even severely damage the business under the different scenarios but, if you’re going to seize the advantage, they can’t wait until you know the way the future will develop. These are the big bets which can make or break the business. Whether you go ahead depends on your own attitude to risk, the potential rewards and losses and how likely you believe the scenario is. They will either make you look a business genius or a fool but at least with scenario planning, you’re going into the decision with your eyes open.

Step 11 – Start implementing your strategy decisions.

Step 12 – Keep monitoring the external environment for indications that one scenario is becoming more likely and reflect that in your emerging strategy.

Scenario Planning Techniques A Quick Summary

There is a lot to take in when you start thinking about using scenario planning techniques to guide your business strategy development.

Here’s a quick summary:

  1. Use PEST analysis and the five forces to identify what may happen in the foreseeable future.
  2. Focus attention on two or three key variables.
  3. Develop logically consistent scenarios
  4. Design a winning strategy under each – compare and contrast to identify things to do now, future options and big bets

When Should A Smaller Business Use Scenario Planning Techniques?

If you’re responsible for strategy in a business employing thousands, then I believe scenario planning should be part of your annual strategic planning process.

If you employ 50 to 250 people – what is classified in the UK as a medium sized company – then you should use the scenario planning techniques I’ve explained only when you believe you’re facing major uncertainty in the wider business environment.

You’ll have realised that scenario planning is time consuming and can take you throw more darkness before you find clarity. It can get scary looking into the future and the options can appear overwhelming as you start using scenario planning.

You’ll also find that some of your managers cope with talking through the uncertainties much better than others. Some people find it much easier to think conceptually and imagine different situations while others are much more practical and grounded in what’s happening in the real world.

These people present a challenge since if you don’t involve them in building up the scenarios, they will reject the implications. The clearer the drivers of the scenarios are, the easier it will be to gain their support.

If you’re a smaller business, then you’re less likely to have problems applying the scenario planning techniques because of the natural closeness of the management team and perhaps as a business owner, your more powerful position in the team.

But the time required to benefit of scenario planning ratio worsens as the business gets smaller. That’s just because the returns from winning will be smaller.

However scenario planning can still be useful for even the smallest of businesses.

If you’re business is in a town or city dependent on one big business – or even a specialist trade – and that dominant force is under threat then you have two or three clear scenarios:

  • Things carry on as they are
  • The big business closes its local plant
  • The big business closes another plant and moves its production to your local plant

Now imagine you want to grow your retail business and you can do it by increasing the size of your current store, opening up a second store in another part of the town or city or opening up a second store in another town or city.

Scenario planning helps you to make judge each of the options and make a more informed decision about which is the best option.

If you’re the owner of a small or medium sized business and you’re waking up in the middle of the night worrying about what may happen if events play out in certain ways, then it’s clear that your subconscious is wrestling with fundamental uncertainties.

It’s worthwhile committing yourself to thinking through the uncertainties and working your way through the scenario planning techniques. Uncertainty creates stress which causes mental processing difficulties rationally and emotionally.

If You Don’t Want To Use The Scenario Planning Techniques

If you don’t want to use the scenario planning techniques outlined above then you have two choices:

  1. To make bold strategic moves effectively on gut-feel or the toss of a coin
  2. To keep your strategies focused on the short term, no lose options

Both are a gamble when their is fundamental environmental uncertainty.

In the first option, you may win big or you may lose.

In the second, by playing it safe, you may be condemning your business to a long term struggle against a competitor who has seized the advantage.

Have You Used Scenario Planning?

If you’ve used scenario planning in your strategy development, I’d love to hear about your experiences so please leave a comment.

Did the scenario planning help you to think through the issues more clearly?

Do you have any special tips to share about scenario planning?

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