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Scenario planning and forecasting: Are you using the right tool for the job?

Scenario planning, rolling forecasts, contingency planning and so on are all techniques used to inform decision-making and deal with the uncertainties arising from the pandemic. But which approach is the right one for you?

In this brief guide we define several techniques and identify what they are best suited to achieve and some traps to avoid. The terms you use in your business may vary. This does not matter as long as everyone involved is clear about what you are trying to achieve, the process involved and the outputs required.

The approaches below can be combined in different ways. However, be careful not to make things overly complicated or burdensome.

Strategic scenario planning

Strategic scenario planning focuses on the medium to long term to identify how the world might change and the strategic responses that may be required. Such scenario planning considers known trends, eg demographics and climate change and makes assumptions around key uncertainties eg consumer behaviours and competitor actions. From these a number of plausible scenarios are created and their implications considered. Outputs are usually in narrative form but sometimes the financial implications are modelled.

Royal Dutch Shell has been at the forefront of strategic scenario planning and publishes much of its work. They have created three scenarios in response to the pandemic – ‘Wealth first, Security first, Health first’.      

Best for

  • Considering strategic changes
  • Innovative thinking
  • Identifying ‘no regret’ actions that would be appropriate for any scenario
  • Creating a forward looking and change oriented culture

Main trap

  • Becomes an intellectual exercise with no practical results

Operational and financial scenario planning

Operational and financial scenario planning focuses on the short to medium term. It involves looking at current market conditions and generating a number of ‘what if’ scenarios – often plausible base, best and worst cases. These may be created bottom up, by working across the organisation to identify conditions on the ground, key assumptions and possible actions. They can also be created top down by making some broad assumptions about revenue and cost changes and then working through the implications and required actions. With high uncertainty and rapidly changing circumstances scenarios may need to be frequently revisited.

Best for

  • Managing cash flow
  • Raising finance in short to medium term
  • Reacting to change
  • Identifying ‘no regret’ actions that would be appropriate for any scenario

Main Trap

  • Failure to closely link financial outcomes to operational actions and market forces

Base case scenario/forecast

The base case forecast is the forecast upon which most business decisions and actions are based. It represents the most likely outcome given current information. It is often derived after considering a range of scenarios. Again, with high uncertainty and rapidly changing circumstances the base case forecast may need to be frequently revisited.

Best for

  • Decision making
  • Managing cash flow
  • Raising finance in short to medium term

Main trap

  • Failure to update base case in response to new circumstances and information

Rolling Forecasts

Rolling forecasts are forecasts which are updated regularly to look ahead for a set period, often the year ahead, rather than forecasting to a set date, such as the year end. This ensures that the business is always looking a suitable distance into the future which matches the business need rather than an arbitrary accounting period. Rolling forecasts will usually focus on the base case forecast. Where the rolling forecast shows that the current business approach is not working this should trigger actions based on other prepared scenarios if relevant or newly developed scenarios if necessary.

Best for

  • Managing cash flow
  • Managing the business
  • Reacting to changing circumstances

Main trap

  • Process becomes a game-playing ritual rather than an essential management tool

Driver based forecasting

We mention driver-based forecasting as a means of generating and updating forecasts and scenarios automatically based on the main business drivers. All techniques described should be grounded in the link between operational actions and financial outcomes.

Drivers may be wide ranging, but examples include footfall, commodity prices and GDP growth. Lead indicators are particularly useful for example sales pipelines. With appropriate data feeds and business modelling, forecasts can be quickly updated.

Best for

  • Automating, at least in part, chosen forecasting approach
  • Accelerating production of forecasts in response to new data

Main trap

  • Poorly though through cause-and-effect relationships between interrelated business drivers and financial outcomes

Sensitivity analysis

Sensitivity analysis involves applying a range of changes to key business drivers and looking at the impact on a forecast or financial scenario. For example, we may take our base forecast and look at the impact of different footfall assumptions on revenue, costs and cashflow while holding all other assumptions constant.

It is possible to vary more than one driver and some use probabilities and Monte-Carlo simulations to show the relative impact of different drivers. This can become complex and difficult to manage and communicate. Varying multiple assumptions may be better dealt with through a limited number of operational or financial scenarios.

Best for

  • Identifying the most impactful drivers on forecasts
  • Looking at the impact of a new piece of information, such as updated foreign exchange rates, on financial outcomes

Main trap

  • Getting bogged down in detail and missing more important issues

Contingency planning

Contingency planning is about developing detailed action plans to respond to a specific situation. This could be around how the business might respond to a scenario where the business runs out of cash and needs to raise finance. Or it could be around issues such as a cyber-attack or natural disasters. Businesses have to decide which situations it is most important to prepare for. However, some aspects of contingency plans stand up to range of situations, such as communication cascades and staff being able to work from home.

Best for

  • Managing risk
  • Responding to crises

Main trap

  • Not testing the plan

Example of combining techniques

The ways in which the techniques are combined will depend on individual circumstances, priorities and resources available in the business. The following example may help you think things through.
If time permits and significant strategic change is being considered, start with strategic scenario planning. For the most useful and plausible strategic scenarios develop more detailed operational and financial scenarios. Choose a base case scenario/forecast and maintain it using a rolling forecast preferably automated through a driver-based forecasting approach. If useful overlay sensitivity analysis on the most useful scenarios to develop further insights. The work on scenarios will highlight risks which together with other risk management processes can be used to determine what contingency plans need to be put in place.

Related Business and Management Faculty Resources

What lessons have you learnt?

We would be delighted to hear about the insights you have gained when it comes to scenario planning and forecasting – please email us.