What Is Scenario Planning? Strategy, Steps, and Practical Examples

It’s commonly accepted wisdom that every modern organization must be equipped to operate in a VUCA—volatile, uncertain, complex, and ambiguous—world. To succeed, business leaders must be prepared to respond to both risks and opportunities. Scenario planning is a way to assert some control by identifying assumptions or predictions about what may happen in the future and determining how an organization will respond.

By building organizational awareness of what could happen, leaders may spot warning signs of brewing challenges and respond accordingly. When a worst-case event arises, scenario planning documents add tremendous value by playing out multiple outcomes and listing immediate steps to contain damage.

Such plans are also valuable for best-case scenarios. What will the company do if a product goes viral and demand spikes 300% overnight? Or how about when an acquisition opportunity lands unexpectedly? Working through these situations ahead of time puts an organization in the best position to respond to them.

Scenario planning, ultimately, tells a story with many possible endings. Crafting the narrative requires a clear set of assumptions about potential business realities and ensuing outcomes.

What Is Scenario Planning?

For businesses, scenario planning helps decision-makers identify ranges of potential outcomes and estimated impacts, evaluate responses, and manage both positive and negative possibilities. From projecting financial earnings and estimating cash flow to developing mitigating actions, scenario planning is more than just a financial planning tool—it’s an integrated approach to dealing with uncertainty.

But it’s more than just a way to recognize and mitigate risk or plan for growth situations. Scenario planning is also about visualizing different representations of an organization’s future based on assumptions about the forces driving the market—some good, some bad.

Scenario planning is a process pioneered by the US military, which today runs such exercises looking up to 20 years out to guide R&D efforts.

Key Takeaways

• Scenario planning helps decision-makers identify ranges of potential outcomes and impacts, evaluate responses, and manage for both positive and negative possibilities.
• By visualizing potential risks and opportunities, businesses can become proactive versus simply reacting to events.
• There are a number of templates and formalized frameworks for scenario planning,
• Looking at two fictional firms, a software company and a wholesale distributor, helps illustrate scenario planning process options.

Why Is Scenario Planning Important?

Scenario planning can provide a competitive advantage by enabling leaders to react quickly and decisively. Because a situation has been thought through and actions documented, no one has to scramble amid a crisis.

Scenario planning also gives executives and boards of directors a framework to make nonemergency decisions more effectively by providing insight into plans, budgets, and forecasts; painting a clearer picture of key drivers for business growth; and laying out the potential impact of future events.

Scenario Planning Advantages and Disadvantages

Rudimentary scenario planning is beneficial for most companies, if only in the context of developing disaster recovery/business continuity plans. A comprehensive scenario planning exercise, however, takes more time, effort, and, money, so determining whether doing one makes good business sense is an important first step. Understanding the pros and cons of such an effort is a good place to start.

Advantages

• Scenario planning helps executives understand the effects of various plausible events.
• Finance, operations, and other teams can prepare responses ahead of time.
• There’s an element of knowledge management to scenario planning; the company can capture the insights and recommendations of key personnel. The resulting documentation ensures that the company can enact responses even if certain individuals are unavailable during an actual extreme event.
• Scenario planning processes encourage communication and greater alignment among stakeholders around strategic business objectives and future opportunities and risks.

Disadvantages

• Scenario planning can be a significant undertaking. It can be a lengthy process to collect data and driving factors; for large enterprises, plans can take months to create.
• Factors that impact plans can change quickly. That means scenario planning must be a living process, with constant updates as conditions and assumptions evolve.
• Scenario planning requires specific expertise, so companies may need to bring in specialized analysts or subject matter experts to guide the process.
• Scenario planning deals with ambiguity and uncertainty; leaders who are more comfortable with hard and fast data and rules may find the process challenging.
• Common pitfalls include cognitive bias that can skew analysis and planning, analysis paralysis that can result from considering too many possible futures, and overconfidence that can lull leaders into a false sense of security.

Types of Scenario Planning

Once an organization has determined that the advantages of scenario planning outweigh the challenges, it’s time to dig into the details. First, it’s essential to understand the various forms of scenario planning and how to apply them.

Some common types of scenario planning include:

• Quantitative Scenarios

  Financial models that allow for 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/factors. Quantitative scenarios are also used to develop annual business forecasts. These models assume that key variables are known and that relationships among them are fixed.

• Operational Scenarios

  One of the most common types of scenario planning an organization will undertake internally. Operational scenarios specifically explore the immediate impact of an event. The scenario then provides short-term strategic implications.

• Normative Scenarios

  These describe a preferred or achievable end state. These scenarios are less objective planning and 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.

• Strategic Management Scenarios

  These are essentially stories that say 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 company leaders to put together because they require a broad industry, economic and world view. On the plus side, they give planners the freedom to brainstorm decisions and a broad storytelling mandate. In some cases, companies bring in analysts or futurists, whose job it is to study trends, analyze the likelihood of future developments, and help organizations prepare for these potential changes.

Scenario Planning Use Cases

Generally speaking, it’s easy to recognize how scenario planning efforts can help businesses proactively navigate future circumstances, make more informed decisions, and increase organizational resilience. But delving into a range of specific use cases for the practice provides even greater clarity around the real-world applications of scenario planning that can lead to better business outcomes.

Some common situations in which scenario planning can deliver value include:

• Evaluating high-impact decisions: Simulating the possible outcomes of significant business choices—such as market expansion opportunities or mergers and acquisitions—helps leaders better evaluate the risks and benefits of their options. By modeling the various scenarios, decision-makers can make more informed choices and also prepare their organizations for any possible disruptions or challenges that could accompany these decisions.
• Informing research and development: Scenario planning can help guide R&D investment decisions. Decision-makers can explore the various ways in which technology trends, marketplace demand, or regulatory shifts might unfold so that they can put their resources behind those innovations that are more likely to succeed in various future scenarios.
• Modeling different financial impacts: Core activities, such as budgeting, risk management, and contingency planning, can all benefit from exploring how changes in demand, costs, or economic conditions might affect the business’s financial health. This type of financial modeling can help the business capitalize on favorable economic situations and make preparations for riding out adverse conditions.
• Developing sales plans: Testing how specific sales strategies might perform under different market conditions—say, a shift in customer demand or the entry of a new competitor—can help companies adjust their plans, better allocate their resources, and optimize their go-to-market approaches. Such scenario planning arms sales teams to better adapt and respond to these shifts should they occur.
• Anticipating potential risks: Risk mitigation is one of the most common and valuable use cases for scenario planning. By identifying, assessing, and planning for potential challenges, business leaders can develop well-thought-out mitigation and response strategies ahead of time. This can help reduce the company’s exposure and strengthen its ability to respond effectively when challenges arise.
• Building supply chain resilience: In recent years, both the fragility of global supply chains and the importance of responding to more frequent disruptions within them has become crystal clear. Companies can model a variety of scenarios (logistical logjams, labor strikes, supplier failures, demand surges) to develop contingency plans, such as diversifying their supply base or shifting their safety stock policies. Scenario planning can also identify weak links in supply networks. This proactive approach increases an organization’s ability to maintain its operations and withstand any supply chain shocks.

Scenario-Planning Examples

Typically, macroeconomic expectations are used in conjunction with scenario planning to help the CFO frame near-term expectations for the company 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 fictional companies, a software provider and a wholesale distributor, would approach scenario planning during the COVID-19 pandemic.

Company 1: Gimbloo Software is a young business software company that had been experiencing steady growth until the pandemic. 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 Gimbloo’s runway.

Company 2: Before the pandemic, the CFO at established wholesale distributor Sunshine Direct had prepared 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 Sunshine Direct found itself operating in the worst-case scenario—red—within a matter of weeks.

Questions both companies considered:

• What is the issue that we are trying to assess?
• How far out are we trying to predict?
• What are the major external factors likely to impact our scenarios?
• What are the key internal drivers that we need to address?
• What are the risks to the scenario?
• Do we have the right data, technology, bandwidth and skills to develop and maintain scenario plans?

Sunshine Direct’s scenarios are based on order volume and its ability to fulfill orders efficiently. Because the negative effects of the pandemic were so sudden, 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.

It quickly lost orders from most customers with physical retail locations—infection rates and lockdown orders have a direct impact on sales. Internally, Sunshine Direct 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 typical output.

Sunshine Direct’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.

Scenario Planning vs. Business Continuity Planning

Scenario planning is often conflated with business continuity planning. While both are structured processes for helping a company navigate the future, scenario planning plays a longer game that considers revenue over time. Business continuity planning is about how your business will react to a disaster, such as a warehouse fire or earthquake.

In both processes, the journey may be as valuable as the final work product. By bringing leaders together to think through what could affect your business, you may head off potential risks.

Meanwhile, Gimbloo’s challenges are less dependent on outside stakeholders. Its management and private equity partners met early in the crisis to establish a plan. They came to an agreement that new business and additional sources of funding aren’t likely in the next few months, so the key focus is extending runway by cutting discretionary costs and being prepared to adjust headcount. The company’s PE partners aren’t likely to sit by and watch Gimbloo run out of money, but before providing additional funds, they will want to see that the company has cut wherever possible.

Leadership made the assumptions 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.

How to Approach Scenario Planning Work

Scenario planning can be a significant undertaking, requiring a level of comfort with speculation and ambiguity and the ability to ground the practice in reliable data. However, business leaders need not start from square one. There are proven best practices, as well as some common pitfalls to avoid, that can help them approach their efforts most effectively and make sure the process is credible and actionable.

Actions to Take

1. Secure commitments from senior management, select team members, and organize scenarios around key issues to be addressed and evaluated.
2. Define assumptions clearly, establish relationships between drivers, and limit the number of scenarios created.
3. Make sure each scenario presents a logical view of the future.
4. Focus on material differences between scenarios.
5. Indicate KPIs and refresh scenarios and update assumptions on a regular basis.

Actions to Avoid

1. Avoid developing scenarios without defining the issues first.
2. Don’t develop too many scenarios; three is a good starting point. Beginning with your best guess at how business will go, add one scenario for things going better and another for things going worse. A good starting point is 50% for best guess, then 25% for things going better, and 25% for things going worse.
3. Do not attempt to develop the perfect scenario; more detail does not mean greater accuracy.
4. Avoid becoming fixated on any one scenario.
5. Don’t hold on to a scenario after it has ceased to be relevant.

3 Steps to Better Scenario Planning

1. Identify Critical Triggers Even Amid Uncertainty

   When faced with a crisis, finance leaders quickly establish guidelines for how the organization should respond by developing multiple scenarios. These scenarios are built on a set of assumptions around events that affect the survival of the organization and should trigger a series of actions.

   In times of crisis, companies need to combine historical data with plausible outcomes to determine ramifications for each part of the organization. Scenario plans can give leaders breathing room to slow down and assess economic, political and environmental factors. These prioritized factors are a critical part of crisis scenarios.

2. Develop Multiple Scenarios, but Keep It Simple

   When building multiple scenarios, it’s easy for finance teams to feel overwhelmed by the range of potential outcomes. How can anyone properly plan for so many possibilities? Simply put, you can’t. That’s why it’s best to keep it simple. Focus on two to three major uncertainties and build scenarios from there. Finance leaders need to prioritize and develop perspectives about each of the scenarios to help the company navigate.

3. Build a Nimble Response Strategy

   Each scenario should contain enough detail to assess the likelihood of the success or failure of different strategic options. Once this is all in place, finance leaders can create a framework that helps the executive team make decisions. Any decisions made need to be monitored in real time so the team can be nimble in its ongoing response.

Strategies to Manage Scenario Planning Projects

As has probably become clear, the scope of scenario planning is limited only by leaders’ time and imaginations. There must be guardrails on the project to keep the time investment in line with expectations. Here are some key considerations in managing scenario planning scope creep:

• Recognize the importance of the team’s time.
• Spend more time on the creation and analysis of problems/questions, and less on “what if” tangents.
• Define important outcomes.
• Decide how you will put your scenarios to use; that will inform scope.
• Establish how you will assess success.
• Recognize an evolving context and narrative.

Sunshine Direct’s models were based on assumptions that didn’t work during the pandemic, but the mitigating actions planned in its original scenarios still applied, even with different conditions.

For example, pre-pandemic scenarios used fuel costs as a trigger, anticipating higher prices in the event of a crisis. After spending a few weeks assessing key metrics for the business, the company realized that because diesel fuel is cheap, it can be more competitive on rates and pay truckers better than Amazon—the opposite of what it expected in its original scenario planning. Fuel is so inexpensive, in fact, that sending out partly filled trucks is a more reasonable proposition than it was just a few months ago. Because the company had already planned mitigating steps for scenarios that relied on high fuel costs as a trigger, it was able to work them backward without additional planning.

Operating at 60% of regular revenue, management assessed what its existing customers needed and got the sales team working on acquiring new customers by thinking out of the box. Sunshine Direct’s next move is to identify small and niche businesses that are operating at reduced capacity and have the sales team contact those that may be having trouble moving partial loads. The projection is that taking these steps will bring revenues up to 80%, which would move the company into a better scenario.

For Gimbloo’s part, leaders began running weekly cash forecast scenarios using a variety of inputs, focusing first on collections and hoping for a week-to-week decline in delinquent payments. Next, they examined new bookings, customer churn and customers reducing licenses. The company’s forecasts are based on recurring revenue, and factors that affect MRR will trigger new actions.

The company decided to focus on its core value: the service it offers. Leaders decided to take on fewer new customers before making cuts to customer service, cloud services, or customer success. It eliminated discretionary expenses, paused hiring, and canceled future marketing events to make up the difference.

If things go poorly and Gimbloo sees a spike in non-renewals and cancellations, leaders plan to seek additional capital from current investors and cut employee costs, such as by furloughs and reducing discretionary bonuses, versus delaying product launches. If it wins new business, the company will begin hiring again and expand its digital marketing footprint.

Scenario Planning and Modeling: Best Practices

1. Assemble the Right Team

   In large companies, financial planning and analysis groups should be included. But while finance professionals can certainly lead the scenario planning process, they won’t be successful alone. This effort needs to connect leaders from across the organization, including business units and HR.

2. Get the Right Data

   For finance teams to execute with confidence, they need the right data, going well beyond the general ledger. To create better, more accurate models, finance needs historical and comparative sales data, headcount and expected growth, and, of course, actuals from the general ledger. They’ll also need to understand the costs of producing products and services, which products are foundational, and which are additive.

3. Model With Basic Scenarios

   Finance teams should consider developing basic low, medium, and high models. A low scenario is where costs and revenues are challenging. The goal here will be finding cost savings while still delivering quality products in a timely manner. A medium scenario assumes that sales will continue to grow based on last period actuals. This scenario will show how the last period’s sales figures compare with forecasts and what adjustments you need to make on headcount and other departmental spending to maintain trajectory. The high scenario is usually based on demand increasing and sales accelerating due to big changes in the market. The goal is to ramp up capacity without incurring costs that eat into margins.

4. Provide Break-Even Analysis

   Break-even analysis will support, with data, decision-making regarding your cash-flow break-even level. It looks at the minimum sales volume your company needs to keep operating normally and sales compensation plans to see if you need to adjust commissions or bonuses.

An ERP Solution That Empowers Scenario Planning

Scenario planning requires good data, and good data requires integration. Without a centralized view of business information, building accurate scenarios becomes a matter of guesswork rather than strategic planning. Companies that have invested in a robust ERP platform, such as NetSuite ERP, are at an advantage. NetSuite ERP provides real-time visibility into an organization’s operational and financial performance within a single, cloud-based solution, empowering business leaders to model scenarios using current conditions and trends, as well as historical data. Decision-makers can quickly and easily access the data they need and be assured of its integrity. The platform also offers “what-if” scenario planning functionality, powering the simulation of different situations—such as a sudden surge in demand or supply chain disruption—to explore the impact on various aspects of business performance, including inventory, cash flow, production, or profitability.

Scenario Planning FAQs

What are the three phases of scenario planning?

The three primary phases of scenario planning are:

• Identification and analysis: Define the scope, objectives, and key drivers of a change that will impact a business, and then gather and analyze relevant data.
• Scenario development: Create possible future circumstances, including how each could unfold and impact the business.
• Strategic response and action planning: Develop and document action plans based on the implications of each scenario.

What’s the difference between scenario forecasting and scenario planning?

Although scenario forecasting and scenario planning may be performed in conjunction with one another, they are distinct business activities. Scenario forecasting is the process of predicting a single, most likely outcome based on historical data and trends; it is often used for shorter-term operational planning. Scenario planning typically involves exploring multiple futures that may have an impact on a business; it is used for longer-term, strategic planning.

Does scenario planning or scenario forecasting come first?

Scenario forecasting typically comes first (although these activities may be performed in isolation from one another). With scenario forecasting, business leaders aim to determine the most likely future based on qualitative data and trends. Scenario planning is a more comprehensive exercise of exploring multiple alternative futures that might arise under certain conditions, helping business leaders make more data-informed decisions for the future or develop responses and action plans should those scenarios come to pass. A scenario forecast could become part of a larger scenario planning effort.