What is scenario planning?

Organizations are turning to strategic planning methods as a way to manage risk and make data-driven decisions. These methods also help businesses to be prepared for the “what-if” moments outside of their control, such as climate change, market fluctuation and geopolitical shifts.

The scenario planning process helps forecast and identify ranges of possible outcomes and the estimated impact through trend analysis.

By knowing what might happen, organizations and their stakeholders can improve decision-making and manage both best-case and worst-case possibilities. Beyond scenario development, the process also helps organizations formulate strategies to navigate these future scenarios and possible futures.

With scenario planning, organizations can visualize different scenarios and reveal critical uncertainties long before a crisis occurs. This process can provide a competitive advantage by enabling enterprises to brainstorm and think through ahead of time what actions might need to be taken.

Scenario planning also provides detailed insights into plans and budgets. It’s a driving force for executives and stakeholders to make decisions for their organization. Instead of reacting to an event outside of an organization’s control, scenario planning drives proactive problem-solving and innovative thinking. The more resilient the organization can become, the more likely they are to have long-term stability.

The best way to understand scenario planning is through the example of the Royal Dutch Shell company known currently as Shell. The oil and gas company started to use scenario planning in the 1960s when it was dealing with expanded production challenges, and it ultimately anticipated the 1973 oil crisis.

In 1965, the company introduced the Unified Planning Machinery (UPM), which was a computerized forecasting tool used to predict financial flows. This tool led to more conversations within the company about creating possible scenarios and anticipating future events through the scenario development process.

The company devised alternative scenarios based on a range of variables. It did so to try to understand what the future state of the organizations might look like in a world based on free trade or growing geopolitical tensions.

This work played a pivotal role for Shell as it tried to understand and anticipate disruptions. To this day, Shell is asking “what-if” questions and uses the scenario planning process to think about long-term challenges and mitigate risk.

The aim of scenario planning is not just to predict the outcomes, but to understand what forces might have led to them. It’s crucial to look at external and internal business environment factors and integrate scenario planning throughout organizational processes.

The scenario planning process is not the same for every organization and might require extra steps depending on their needs. However, the following are five key steps that every organization can use as guidance.

For there to be a productive scenario planning process, all organizations should start with establishing a clear objective.

This objective can be a long-term goal or something more immediate. Either way, the organization should envision where it hopes to be in the coming months or years.

After determining the primary goal, teams should analyze how current actions will affect potential outcomes.

Organizations must ensure that these outcomes align with the main objective and understand their future impact to respond appropriately.

There are numerous factors to consider when determining the organization’s direction. These factors might be internal factors like organizational shifts or external factors like geopolitical tensions.

No matter what they are, the organization must have a thorough understanding of each for accurate forecasting and insights.

Much like identifying influencing factors, organizations also need to assess the impact of each scenario. This approach involves creating multiple scenarios and determining how likely each one might be depending on the conditions, assumptions and probabilities.

After the assessment comes the evaluation of the impact of each scenario. Organizations must consider potential impacts and determine a proper course of action.

Finally, the organization must develop early indicators for each scenario.

This step is crucial to ensure that the organization is acting proactively and can detect disruptions or problems before they escalate to major events. Furthermore, it gives organizations and stakeholders the competitive edge to stay ready and be able to navigate issues without panicking.

The following are some of the main advantages organizations might enjoy when employing scenario planning:

• Use detailed analysis: Scenario planning gives organizations insights into plausible scenarios and the data to dive into the potential outcomes of their decisions. The approach provides different data-driven alternative futures, giving decision-makers a comprehensive view of potential contingency plans.

• Promote independent thought: Successful scenario-planning exercises require diverse thoughts and perspectives from individuals with unique demographics. Those individuals involved in the approach are encouraged to think independently and be innovative in the problem-solving process.
  
  
• Mitigate risk: Scenario planning is a powerful tool for risk management. The process helps organizations uncover signs of a potential crisis early on, allowing for timely intervention and the creation of strategic action plans to promote risk mitigation.

• Encourage proactive planning: This forecasting method requires forward-looking strategic thinking. Instead of just looking at historical data, scenario planning encourages organizations to embrace a more dynamic approach to scenario analysis.

Scenario planning comes in many forms. The approach an organization takes will depend on the focus and methodology it chooses to use.

The quantitative scenario planning approach uses three different scenarios: optimistic, pessimistic and best guess.

The optimistic scenario plays out the best possible outcomes for the organization. The pessimistic scenario explores the worst-case scenarios, such as a market crash or environmental factors outside of their control. Lastly, the best-guess scenario considers current trends and financial forecasting to assess the financial impact.

Organizations can use the normative scenario planning method to develop their ideal scenario and outcomes and then work backwards to figure out how to achieve it.

This method is best for long-term planning and organizations looking to set significant goals. It’s a forward-thinking approach that helps organizations develop a template for exactly what they want.

Exploratory scenario planning is an approach that considers a wide range of potential futures depending on particular time frames, volatile environments and numerous uncertainties.

This method builds various scenarios and can help organizations be ready to adapt in real-time.

This method of scenario planning focuses on the short-term and medium-term challenges that an organization is facing. It tends to focus on operational risk or the day-to-day operations and tackle specific issues.

Organizations that have specific concerns—such as supply chain disruptions or labor shortages—might consider this method to develop specific contingency plans.

The strategic management method is another large-picture approach to scenario planning, but it focuses primarily on external influences.

This approach is used to build long-term strategies and help organizations understand their overall direction depending on factors like economic shifts, advances in technology, or social trends.

Organizations in every industry use scenario planning to navigate uncertainty and drive better outcomes. These common use cases demonstrate its versatility.

The entire scenario planning process can be a significant undertaking, and it requires orchestration and collaboration. There are several best practices that an organization should follow to help ensure it’s going to be a successful process:

• Build the right team: Financial professionals typically lead scenario planning. However, they can’t successfully run a scenario planning project without other leaders from within the organization. There is typically a scenario planning facilitator who runs the project and keeps all components aligned.

• Get the right data: Scenario planning requires good data to create accurate models. The scenarios must be based on comparative sales and historical data that is clean and accurate. It will also require a data integration system like an enterprise resource planning (ERP) platform to centralize all business information. Organizations should understand the cost of scenario planning and which products and services are a necessity

• Keep it simple: Scenario planning doesn’t have to be complicated. Finance teams can sometimes feel overwhelmed by the range of possible outcomes and scenarios being built. This is why it’s best to simplify the scenarios and focus on two to three outcomes. If the team is building multiple scenarios, leaders need to prioritize and determine which should get the most attention.

• Lean into advanced technology: There are numerous software solutions for financial planning and analysis (FP&A) that offer scenario planning as a benefit. Many have also started implementing AI-powered insights into their platforms that streamline workflows and provide instant test scenarios. Embracing emerging technology is quickly becoming the factor that puts organizations at a competitive edge.