What Is Scenario Planning? (With Benefits and Examples)
By Indeed Editorial Team
Published 12 October 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
When developing long-term strategies for the future, companies typically consider how different situations may change and impact their business objectives and plans. Scenario analysis or planning is a forecasting technique that can help organisations evaluate changing conditions and better respond to challenges and other factors that might affect their business operations. Understanding what it is and how it works can help organisations to make better decisions and effectively prepare for various situations. In this article, we explain what this type of planning is, discuss its benefits, examine the different types and highlight practical examples of them in action.
What is scenario planning?
Scenario planning is a strategic planning tool that allows organisations to assess future events and help them make decisions that support their long-term business goals. It's a process where businesses examine hypothetical events in the future and try to understand the possible consequences of their decisions and actions. Companies typically perform it to prepare for uncertainty, analyse possible risks and predict potential outcomes of future events. Depending on their analysis, this can help businesses to formulate an effective response or create contingency plans if necessary.
Importance of scenario planning
To understand its importance, consider the implications that future events like market conditions or new technological disruptions can have on a company's operations and revenue. It's essential that companies prepare for the future by using scenario analysis to plan for any changes to their business operations and help mitigate impacts on their cash flow and profitability. A company that conducts this can devise creative strategies and develop new ideas to continue growing the business into the future. Here are some other major benefits:
Stakeholders are important contributors to an organisation's finances and business operations. Performing scenario analysis allows companies to update key stakeholders on the financial projections and forecasts of their profitability. It can help stakeholders to be more aware of any business decisions and potential future events or opportunities. This can be valuable information that can help garner additional support or resources from stakeholders to capitalise on future outcomes or effectively respond to changes.
A corporation may use scenario analysis to highlight potential growth from future business events. They can pitch to investors about the benefits to acquire capital, which can help expand their organisational capabilities and grow the business. Companies generally share the results of various scenario analyses to help investors understand the potential return on investment from supporting the business financially. As a result, investors are confident in their decisions, which enables the company to acquire the funds necessary to achieve its long-term business goals.
Mitigate potential loss
Companies that use scenario analysis are more proactive and resilient to sudden changes, which can help to mitigate potential losses to their business. With scenario analysis, companies can foresee circumstances and events that may impact profitability or operations, which allows them to plan for these situations in advance. Organisations can identify issues before they occur and implement measures to overcome any challenges to their business processes or production.
Optimise resource allocation
Organisations can use scenario analysis to identify areas of improvement and discover potential risks in future plans or strategies. They can evaluate their processes and optimise their resource allocation to become more efficient in responding to potential scenarios if they occur. Companies that better understand the consequences of their decisions can allocate resources efficiently to achieve desired outcomes for their business. For example, if they forecast a future slowdown in demand for a specific product, companies can reallocate resources to produce other profitable goods and save costs.
Performing scenario analysis can help a company discover potential changes in the market and forecast new trends. This allows companies to devise strategies in advance to capitalise on emerging trends in consumer preferences. It also allows companies to model various possibilities and decide the best option to proceed in challenging business environments, such as a market recession or technological disruption.
Examples of scenario planning
Learning the various types and examples can help you apply this tool effectively to help an organisation in different situations. Here are some examples:
In this type, companies adjust variables in financial modeling to examine the best and least optimum outcomes of their potential decisions. This can help the organisation understand expectations when approaching a business situation. Review the following example:
Neuskin is a Netherlands-headquartered company specialising in dermatological and skincare products. They operate on a direct distribution business model and mainly service customers within the European Union (EU) such as Germany, France, Denmark and Spain. Neuskin wants to assess the impact of new EU regulations on consumer health and safety on the business, in particular how the 3% tariff on raw materials sourced outside of the EU may affect profitability.
They use scenario analysis to examine the outlook of market demand, which predicts more environmentally conscious consumers switching to products with natural ingredients. By its calculations, Neuskin may save an additional 2% of raw materials costs if they source entirely from domestic suppliers. In an alternate scenario, Neuskin may bear the 3% tariff and broaden its line of natural skincare products. The strong demand for natural products is expected to net Neuskin an overall 4% increase in profit margins despite the accompanying increase in costs.
Operation scenarios examine how events or circumstances may impact an organisation in the immediate to short-term. It can also study how stakeholders, like customers and vendors, respond to changes, which may affect business operations. Learn from the example below:
TaroTech, an electronics parts manufacturer and distributor, wants to use scenario analysis to understand the impact of a global pandemic and estimate order volume for their products. They believe it can help them to properly forecast order volume and optimise their supply chain activities accordingly, which also allows for more efficient management of accounts receivable and cash flow. Seenario analysis shows that the pandemic and resulting lockdowns may lead to a slowdown in physical retail sales and orders.
Furthermore, safe distancing and stringent sanitisation workplace measures can increase expenses and may limit their warehouse production to under 70% of normal operating capacity. To effectively prepare for this scenario, TaroTech executives decide to focus on fulfilling pre-orders during this period. In anticipation that suppliers may provide a lower output than usual, TaroTech plan to make bulk purchases of raw materials in the preceding two quarters. In the interim, they intend to use this to manufacture products to fulfil pre-orders, which can also help stabilise accounts receivables and ease cash flow.
Interactive scenario analysis can test for the relationship and impact that different variables have on the organisation when interacting with each other in a business environment. Here's an example:
Magix is launching a new web3-based authentication and password management solution for enterprises. They decide to conduct a scenario analysis to determine how businesses in the market might deploy their SDK and like the service it provides.
They may choose to look at the fastest growing blockchain and decentralised applications and examine whether they're using an existing private key management solution. Also, they may check if they have any competitors that offer a similar solution as this might affect the market adoption of their service. Magix can also consider if its solution allows for cross-application integration, which may differentiate its service from competitors and attract big vertically integrated DeFi platforms to its product.
Organisations use normative scenario planning to help them understand their objectives and find the optimum way to achieve their business goals. Review the example below:
Talisman Enterprises aims to build a 40,000 sq foot warehouse next year to meet an increase in demand for its products. They conduct scenario analysis to check if a rise in raw materials and whether an increase in demand for commercial properties like factories and warehouses might affect this plan. One factor they may examine is the approximate yield if the new warehouse is built and whether the increase in production can satisfy customer demand.
Another scenario can simulate a subsequent drop in customer demand, which may lead to underutilisation. In response, Talisman Enterprise can set aside 30% of the warehouse for other production or choose to rent the space out. This can also benefit the company in the event that the demand for commercial warehousing increases. To ensure that they can manage raw materials costs, Talisman can consider entering into partnerships with other suppliers. After analysing various scenarios, Talisman decides to proceed with the construction of their warehouse.
Companies conduct probability-based scenario analysis to study trends and determine the likelihood of an event or outcome. Here's an example:
BSC Construction Services wants to estimate the probability of companies choosing to continue extending more work from home and offering remote opportunities to employees. They can check for any increase in demand for virtual office solutions and co-working spaces. Another area they can look at is the adoption of teleconferencing software by companies, as it can suggest a lower dependency on using office space to host meetings.
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