Scenario Planning Definition
Scenario Planning is prediction of future scenarios and gauging the effect of the scenario in the business. So it helps management to be prepared for adversities in businesses that may arise due to change in current scenario.
It is a particular kind of planning which help businesses to deal with future difficulties. Proper planning is done considering the upcoming scenarios, and businesses lay plans accordingly. All the future investment by the company depends on scenario planning. Extreme scenarios are hard to predict; still, some assumptions can be used to save from the impact.
Process of Scenario Planning
There are several steps that management can follow to perform it.
Step #1 – Predict the drivers of future
Several drivers may affect society. In the early 90 s technological growth started to boom. So like that, one should predict the next driver of the economy. It can be that a particular sector is about to boom, or a sector will lose its demand. Like this, an estimation needs to be done for the next driver in the economy.
Step #2 – Understanding the impact of drivers in your business
After predicting the future drivers, you will have to calculate the effect of that Driver on your business. Whether the next economic change will help you in your business or it will take a hit at your profit levels. Correct calculation of the impact of future drivers is very crucial in scenario planning.
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Step #3 – Gauging the effect of Future Scenario
Carry out a calculation that will help you to understand the possible effects of the predicted economic scenario in the future. The possibilities may start from Best to Worst. This will help you to understand the maximum gain you can pull from the scenario if everything goes as per planning and the maximum loss you may incur if things don’t go as per plan.
Step #4 – Always test unfavorable outcomes even in case of positive Future Scenario
Management should always be prepared for an unprecedented outcome, and plans should always be placed if the estimation of positive future outcomes fails. There are businesses from the past that believed so much in the positive Future Outcome that they didn’t see the competition and adverse change in the economic condition. It should always include the positive and negative impact of a scenario.
Example of Scenario Planning
Company XYZ is an Automobile manufacturing company. They are in the business for 20 years. They did scenario analysis 5 years back and realized that there would be a time when crude will not be available in the future. So they started planning for this scenario and bought a battery manufacturing company 3 years back. They are spending a huge amount of money in Research and Development to build a battery that will last 500 km with One Time Charge. The company estimated the change in the scenario for crude supply and planned its existence without crude.
How to use Scenario Planning?
It will help management develop an understanding of the possible scenarios in the future and their impact on the business. Strategies to deal with the scenario are part of the planning.
It should focus on a few most important scenarios as too many options will make the process complicated. There will be a huge cost involved in tackling all the scenarios effectively.
Scenario Planning vs. Forecasting
Forecasting refers to the calculation of a company’s profitability in the future based on the current and historical data that is available for the company. So forecasting helps you estimate the company’s goal if all the conditions remain stable. It is a quantitative method of judging the future.
Scenario analysis considers different scenarios that may occur in the future and will affect profitability. So scenario Analysis is more subjective. In scenario analysis, judgment is involved, and everything is based on estimation.
- Scenario Planning helps management to be prepared for adversities in businesses that may occur due to shifting in the demand curve, economic condition, political condition, etc. So it helps management to draw a plan to fight negative circumstances in the future.
- Budgeting is the most important part of any project. If any project may be affected by any change in the future scenario, then the required return from the project will also change. So it also helps in budgeting decisions.
- Good planning helps to judge the performance of a manager. When a manager tackles the situation very comfortably, it shows the power of the manager’s scenario planning. So it helps a manager to improve its performance in the business.
- It is an estimation of probable scenarios; it may or may not happen. So when a manager starts to depend too much on scenario planning and starts making all the decisions based on that, then a wrong estimation may hamper the business to a great extent.
- Scenario estimation should change all the time; the manager should perform proper updates on the scenario planning model at regular intervals.
This has been a guide to Scenario Planning and its definition. Here we discuss the process, example, matrix, and how to use it along with advantages and disadvantages. You may learn more about financing from the following articles –