Steve Player is the founder of Future Ready Finance, leader of the Beyond Budgeting Roundtable in North America and spoke at AFP’s 2020 FinNext conference.
Scenario planning addresses the key question: What do we do? It enables you to respond to changes that cause your existing plans and forecast to be radically revised in order to deal with a new and different operating environment requiring rapid response. Examples of this could include events that radically change the demand for services, such as the COVID-19 pandemic, or the emergence of new business models that create disruption such as Airbnb, Lyft, or Uber.
It’s about achieving your targets under any conditions. Your organization needs to have targets out there. Even if you do not have to have a strategic plan, most organizations still have a strategic direction. What are we trying to be? Where are we trying to go? That objective drives all planning.
Things that I can see or shape through normal planning, such as demographic shifts, continued maturity of products, or responses to known competitors’ actions, I don't need scenario plans to deal with that. When thinking of scenario planning, I’m looking for the radical changes that happen — which are usually event driven.
Some finance professionals make the mistake of thinking scenario planning just means multiple plans. They think their organization is doing it because they produce a base case plus a high and a low case (typically plus or minus 10%). This type of planning is more appropriately called sensitivity planning because it addresses, what if the business is a little stronger or a little weaker than we planned. While that may be helpful, it rarely challenges your business because your basic approach stays the same.
To be truly useful, scenario planning needs to address more. We do not want to be limited to what is probable — everybody's thinking about that. Scenario plans should deal with the highly improbable because it often happens. Plus, you get the added benefits of additional ideas that were not ever considered before. It’s the unexpected that really has the ability to trip us up, including the great opportunity that we just didn’t see.
It also makes your team more ready. Creating a future-ready finance team does not mean trying to perfectly predict the future (you can't), but your team can be proactive and think about what could happen and, if it did happen, what your organization could do to seize the opportunity or defend against the risks.
Each scenario is typically written in terms of a high-level situation based on assumptions. Basically, it is kind of a narrative paragraph. We recommend creating four to seven scenarios. The first one should be so good you can barely spend all the money you are making. Examples may include a competitor going out of business, new sales and distribution channels open, there is an opportunity to buy a competitor, a new product becomes a blockbuster, or inputs become available much cheaper.
At the other end, we recommend creating a second scenario so bad that it threatens your organization’s continued existence: bankruptcy is at your door. Potential examples include we just lost our biggest customer, our industry is consolidating, our biggest competitors have merged, the political or regulatory landscape has shifted from the status quo, or key materials for the products we make have dramatically increased in price.
When I think about time horizons, short-term sales and demand planning does not call for scenario planning; there is little I can do. The short-term is focused on responding to immediate demand, typically the next two to six months. My production capability has already been defined based on past investments and related decisions. The actual output may be a little bit better, or it may be a little bit worse. Some small changes can be made, such as staffing a little more overtime, or you can shut the plant down, but you can’t radically change it overall.
Scenario planning focuses on the midterm — the next six to 24 months — decision-making necessary to steer your organization through any unexpected changes. The more that changes, the more scenarios you need to run. Because scenario plans deal with steering you through a new set of conditions, they need to be stated in a playbook form to make it more actionable, and to allow actions to be shifted based on the results as they develop.
When I get out to the longer horizon — two to five or more years — strategic planning is focused on organizational adaptation. This level of strategic planning is always trying to figure out how the world is changing and has some macro changes built into it.
For more information on this topic, download AFP's Guide to Scenario Planning and attend FinNext Virtual 2021 for sessions that include: " The New Normal: Scenario Planning as a Core Part of Your Financial Management Process."