Charting A Future of Growth with Scenario Planning
Updated: Nov 16, 2022
When assumptions about business as usual are challenged, the conversation must change from making predictions to asking “what if?” The COVID-19 crisis has demonstrated that business leaders cannot bet on a single outcome. Instead, they need to consider, "Will there be fundamental changes to our business model, and to our customers’ expectations?” “What new opportunities will arise?” “How can we position ourselves for recovery and growth?”
Boards and other stakeholders look to the CFO and the finance team for answers and to make difficult decisions that will have a long-term impact. Enter scenario planning, a tool that allows finance to see various "what-if" possibilities and determine the best course of action for each. Organizations can reconcile short-term requirements with long-term priorities using this strategic planning method, which integrates cash-flow forecasting and business forecasting.
“After 10 years of positive economic conditions, a lot of organizations had de-prioritized or shifted focus away from the overall discipline of strategic planning,” said Scott Leshinski, a managing director at Huron Consulting, a firm that has helped more than 600 companies transform their planning processes. “A lot of organizations are now starting to shift back toward strategic planning, so it’s creating a renaissance of this capability.”
According to Leshinksi, there’s a focus on strengthening the balance sheet and optimizing cash-flow and capital structure, as companies look to understand the influence of key decisions on the bottom line. For many, this means modifying their operations, reallocating resources, or transforming their business models to capitalize on new opportunities.
Financial planning processes are benefiting greatly from digital cloud technologies. They provide an alternative to spreadsheets, traditional on-premises technologies, and niche solutions that are insufficient for understanding the impact of outlier events like COVID-19 and coordinating plans across all lines of business. They've also proven their effectiveness as organizations have transitioned to a remote workforce model.
What is Scenario Planning?
Scenario planning is the process of making assumptions about various possibilities that may or may not materialize in the future and have an impact on the business. After that, different plans are made to respond to each of the possible events. Scenario planning is unique in that it encompasses elements of strategic planning and risk management to try to mitigate major business impacts by anticipating occurrences that could have adverse effects.
Scenarios are also collaborative, involving teams of people from various levels within an organization. Generally, these scenarios have a creative component, rather than being just based on quantitative number-crunching, providing more flexibility and preparedness to deal with risk and uncertainty.
Scenario planning is more than a financial tool when executed properly. It's an integrated approach to coping with uncertainty and visualizing the future so that finance organizations may create a foundation of agility and advance the business.
Types of Scenario Planning
1. Operational Scenarios:
This is one of the most common types of scenario planning a company will internally execute. Operational scenarios specifically explore the immediate impact of an event. The scenario then provides short-term strategic implications.
2. Quantitative scenarios:
Quantitative scenarios are financial models that enable the presentation of best and worst case versions of the model outputs. These models can be quickly changed by altering a limited number of variables and factors. Quantitative scenarios are also used to crate yearly business forecasts. These models assume key variables are known and that relationships among such variables are fixed.
3. Strategic management scenarios:
These are essentially stories that describe little about the company or industry, but more about the environment in which products and services are consumed. These are often the most challenging scenarios for organization leaders to piece together because they require a broad economic, industry and world view. On the positive side, strategic management scenarios empower planners with the freedom to brainstorm decisions and a broad storytelling mandate. In some cases, companies bring in analysts or even "futurists".
4. Normative scenarios:
This sort of scenario planning describes a preferred or achievable outcome. These scenarios involve less objective planning and are more geared toward statements of goals. These goals are not necessarily about an organizational vision, but more about how the company would like to operate in the future. Normative scenarios are often combined with other types of scenario planning as they provide a summation of changes and a targeted list of activities.
Scenario Planning & Modeling Examples
Typically, macroeconomic expectations are used in tandem with scenario planning to help the CFO frame near-term expectations for the organization and to level set expectations in departments. The fundamentals of scenario planning are the same, even if the particulars across industries and within businesses vary. To illustrate this, consider how two organizations, a software provider and a wholesale distributor, would approach scenario planning in the face of the pandemic's volatility.
Company A: Before the pandemic, the CFO at established wholesale distributor Company A had created three scenarios based on order volume: green, yellow and red. Each scenario encompassed a new set of mitigating actions, using order volume as a metric to trigger when it was time to enact each action sequence. However, the retail freefall meant that Tar Heel Direct found itself operating in the worst-case scenario — red — within the first month of the pandemic.
Company B: Company B is a business software company starting out that had been experiencing steady growth until COVID hit. The leadership team hadn’t undertaken any scenario planning, but its CFO had lived through both the dot-com bubble and the Great Recession and was ready to act quickly to protect the organization's runway.
Company A's scenarios are based on order volume and ability to fulfill orders efficiently. Due to the suddenness of the negative effects of the pandemic, the company decided to set milestones for every 30 days in anticipation of delayed accounts receivable as well as reduced ability of retailers to accept products.
They quickly lost orders from most customers with physical retail locations, as infection rates and lockdown orders have a direct impact on sales. Internally, Company A has taken safety precautions for its workers. Social distancing and increased sanitization measures mean that warehouse teams are operating at about 60% capacity. Suppliers and customers are in roughly the same boat, with suppliers being affected too, though not as dramatically as retail outlets. Some incoming product shipments will be delayed, or suppliers may be able to provide only fractions of their normal output.
Company A’s leaders are in close communication with suppliers and customers, and the firm monitors government data and industry reports to try to stay ahead of trends; however, the future of retail is uncertain, and it may need to explore new sources of revenue.
On the other hand, Company B’s obstacles are less dependent upon outside stakeholders. Its management and private equity partners met early in the crisis to create a plan. They reached an agreement that new business and additional sources of funding aren’t likely in the next few months, so the critical focus is extending runway by cutting down on discretionary spending and being prepared to adjust headcount. The company’s PE partners aren’t likely to sit by and watch Company B's partners run out of money, but before providing additional funds, they will want to see that the company has cut wherever possible.
Leadership assumed that recurring revenue would stay largely the same and new deals would surge when the economy reopens. If both hold true, they’d begin scaling back the cost-saving measures. They also added a cushion for churn, down-sells and, in the event of an extreme and protracted downturn, some mid-contract cancellations. Any significant changes in metrics would trigger another scenario with further cuts.
The Benefits of Scenario Planning
Uncertainty is usually associated with long-term planning and forecasts, yet the COVID-19 pandemic caused chaos in just a few months. Agility has become critical in the short-term forecasting process as a result of this.
CFOs and their teams were already under pressure to deliver better, faster data and to build digital finance organizations that could maintain the rapid pace of change. This has accelerated, with finance now expected to guide the company through a crisis, maintain operations, and drive innovation. To do so, they must gather and analyze data from a variety of sources within the organization, offering knowledge that aids not only planning and forecasting, but also closing and reporting.
With scenario planning as a key component of a modern cloud-based solution, CFOs can understand when, where, and how to adjust to disruptions. They can model multiple scenarios, a capability that has become a requirement in a time when historical trends and assumptions are no longer reliable.
“What we’ve learned over the last several years, but more specifically in the last several months, is that flexibility and agility are key,” said Patrick D’Addabbo, director of Strategic Finance at Lululemon. The move to digital cloud technologies shortened processing times reduced manual processes, and enabled Lululemon’s finance team to model multiple what-if scenarios, faster, to address uncertainties and guide business decision making.
These capabilities are particularly beneficial in industries that have been severely disrupted. For example, retailers have had to account for the staggering reopening of physical locations, fluctuations in the balance of online vs. in-store sales, and changes in customer purchasing. Professionals in higher education have had to model for a wide range of student enrollment, revenue levels, and learning delivery options. Across industries, several businesses have shifted their focus to meet new demands: Clothing companies created N95 masks, distilleries switched from creating liquor to manufacturing hand sanitizer, institutions moved classes online, and commercial airlines began offering cargo-only flights to fill empty passenger cabins.
Technology Equipped For A Changing Environment
In today's world, when change is inevitable and outlier events like COVID-19 have unanticipated consequences, spreadsheets and antiquated tools are no longer enough. Spreadsheets result in broken formulas, inaccuracies, and time spent manually entering data and consolidating data. Traditional planning methods, such as single-point predictions, ignore the presence of uncertainty by combining everything from capital expenditures to acquisitions into a single projection rather than a series of scenarios.
Cloud solutions with advanced capabilities are helping finance teams optimize the planning and forecasting process overall, enabling organizations a simpler planning process that is based on sophisticated models, which would be difficult to replicate in spreadsheets. These simplified planning tasks create more time for strategic risk and opportunity analysis, to help identify how the company can grow faster. Additionally, they are built on faster scenario modeling and consolidations that enable finance teams to provide real-time recommendations to business leaders. With cloud-based solutions finance teams gain immediate access to data and predictive analytics enabling finance to deliver recommendations, frequently, to help with strategy formulation and evolution.
Don’t Get Confused With Forecasting
Forecasts are based on the premise that the world will appear roughly the same in the future as it does now. It is a less creative approach that fails to account for substantial changes in the business environment, which can provide significant problems to organizational strategy and performance. Furthermore, forecasts do not take into account risks and uncertainties as part of a broader stakeholder dialogue or research project.
Forecasting relies on quantitative inputs and techniques to anticipate what will, or should, happen in the future, primarily through the interpretation of previous data. It is a short-term method that provides assurance based on known variables in the system.
To put it more bluntly:
Forecasts present only one possible future, whereas scenarios present several possibilities. Neither technique is superior to the other; they merely provide distinct methods to solving problems and should be utilized in tandem.
The table below compares and contrasts various characteristics of scenario planning and forecasting, as well as explains the differences.
There are six common questions to consider when determining which technique to use for a problem or opportunity to identify whether scenario planning or forecasting will be more effective:
Is the future uncertain and unpredictable, or certain and predictable?
Are one or multiple futures more likely?
Is the focus on qualitative or quantitative analysis?
Is the organization looking for an objective, fact-based discussion with stakeholders or a subjective, wider-ranging discussion?
Is the organization looking for a shorter-term (within one year) or longer-term (multi-year) perspective on the future?
Can the analysis results be replicated on an ongoing basis, or are they a one-time representation of unique information?
What’s Next For You
Start visualizing and planning your future. As the saying goes, if you fail to plan then you plan to fail.
CFOs on the forefront of change can do four things today to prepare their teams, and their companies, for tomorrow:
Increase their use of scenario planning to manage risk and uncertainty, so they can plan for a range of scenarios and outcomes and assess how to respond.
Take use of cloud capabilities such as built-in emerging technologies, automated planning processes, real-time reporting and analysis, and secure access anytime, anywhere.
Connect planning across finance—and all lines of business—to empower collaboration, data sharing, and big picture strategy.
Select a trusted partner to assist them in moving forward—one that offers robust what-if scenario modeling as well as related planning and forecasting capabilities.