Scenario Analysis: how to achieve direction amid turbulence 

Experience tells us that the worst decisions are those we make in a climate of anxiety in the face of an uncertain context without adequate analysis. However, in a situation of few certainties it becomes more necessary than ever to understand uncertainty and not sweep it under the rug. 

There are different approaches depending on the information available, the speed at which the decision must be made and the impact of each key variable. In a context like the present, the scenario approach could provide us with a robust yet practical approach, since it allows us to visualize several potential futures and not be committed to a single possible future.

Scenario analysis emerged in the 1950s, mainly in the US and France, as a method to be able to manage military strategy. It was later transferred to the private sector where companies like General Electric and Shell used it successfully during the 1970s oil crisis. The method has become notorious since then as a tool to manage business strategy in the face of an uncertain future. 

Through scenario analysis, the goal is not an accurate prediction of what will happen, but rather to understand the possible ways in which the future may present itself, in order then to be able to propose appropriate responses for each one. In this way, it is possible to strengthen strategic discussion by jointly exploring different dimensions of the environment and thus prepare ourselves for each scenario as best as possible. This prevents us from placing all our bets on winning in a single future scenario and losing in the rest.

Below, we share some recommendations to keep in mind when doing this type of analysis, based on our experience.

What to keep in mind when conducting scenario analysis 

Identify key variables

In order to conduct a scenario analysis that provides value to the business, the first thing we will need to understand is which are the uncertain variables that have the greatest impact on it. In a context like the present one, there are many uncertain elements and also a lot of information circulating trying to predict them. However, it is likely that many of them do not have a direct impact on the results of our plan, or that their impact is less than that of other variables that do move the needle on our results.

Focusing on key variables will allow us to discern between background noise and what we really need to hear in order to make timely decisions.

Understand their behavior

What will the probable evolution of these key variables be? What are the main factors that affect their behavior? Each variable has its own behavior and not all correlate in the same way with macroeconomic indicators, consumer reaction or the evolution of a pandemic.

Understanding the specificity of each variable and the main factors that impact it will give greater granularity to our analysis.

Generate scenarios

Having clarified this limited set of variables, scenarios can be established based on their evolution. The combination of the different possible behaviors of the variables is what will allow us to generate those future scenarios.

However, scenarios are not just a set of grouped variables, but each one must be constructed by specifying its key aspects in as much detail as possible. In this way we will have more vivid images of each potential future that allow us to concretely understand the conditions in which the business could develop.

For example, when different macroeconomic scenarios are analyzed illustrated with curves that take the shape of different letters. There is talk that the economic impact could be V-shaped, with a sharp drop and rapid recovery. Reference is also made to the U shape where the lowest level is prolonged for a longer time, the L shape with a more pessimistic outlook and some even speak of a W. These analyses refer to a generic behavior, although – of course – the most accurate thing is to understand how each of its components impacts our industry, and in particular us. In this way, we can prepare ourselves much better for whatever futures may come our way.

Then, for each of these scenarios we can think of indicators that allow us to understand if we are approaching them in order to act accordingly. 

When we can think in advance of the decisions to be made in each “possible world”, those indicators can be thought of as triggers for specific actions (contingency plans or even opportunity capture plans).

Analyze strategic alternatives

In this last step, we seek to think about the different decisions to be made and the possible results of each of those courses of action for each scenario. That is, we will need to think about how we would do in each of the alternatives for each of the different scenarios we have generated. 

In this way, we will be able to decide to move forward on that most robust path that allows us to optimize the result in the most probable futures and also what we should do if the scenarios that fate has in store for us were different.

Although it can be combined with other methods to simulate more robustly what may happen in the future, scenario analysis is a practical approach that allows us to quickly visualize the impacts of uncertainty on our business. In this way, we will be able to better understand the pros and cons of each strategy when making a decision and be better prepared in a world of few certainties.

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