Innovation

Scenario planning

Scenario planning is a methodology for understanding how long-term changes in the business environment (such as political shifts or new technologies) might affect your firm’s competitive position, so that you can prepare accordingly

Scenario planning is a method for understanding how long-term changes in the business environment (such as political shifts or new technologies) may affect your firm's competitive position and preparing for them.

When to use it

● To assist you in understanding how the business world is changing.
● To identify specific threats and opportunities.
● To adjust your strategy so that you are ready for whatever the future may bring.

Origins

Scenario planning was invented by the oil company Royal Dutch Shell. The concept originated in the military world. In the aftermath of World War II, a group led by Herman Kahn at the Rand Corporation began developing'scenarios' about potential future conflicts. His concepts were then adopted by a Shell team led by Ted Newland and Pierre Wack in the late 1960s.

By 1972, the scenario planning team had developed six scenarios centered on the price of oil as well as the likely future behavior of oil producers, consumers, and national governments. When Shell's top management saw these scenarios, they realized how different the world could be if, say, oil prices rose dramatically. As a result, they agreed to make scenario planning a formal part of their overall strategic planning process.

The first oil crisis occurred in 1973, when OPEC was formed in the Middle East and oil prices skyrocketed. None of Shell's competitors were ready for this situation, whereas Shell had been warned. This event demonstrated the effectiveness of scenario planning, and the methodology was quickly adopted by many large corporations.

What it is

Making sense of the future is always difficult. One approach is to extrapolate from major trends (such as rising population and declining oil reserves). However, this approach fails to recognize that major discontinuities will occur from time to time (for example, a new oil drilling technology or a political revolution in China), as well as complex interactions between trends.

Scenario planning mitigates these uncertainties by explicitly acknowledging the existence of multiple possible futures. A wise approach to planning does not assume that the world will function in the same way in ten years. Instead, it identifies two or three plausible scenarios and investigates the assumptions that underpin each one. This enables the company to make the best investments. For example, a company like Shell must consider the possibility that its oil reserves will run dry at some point, which may necessitate investments in alternative energy sources like wind or biofuels.

An effective scenario planning process does more than just paint a picture of how the world might look in the future; it shapes the firm's strategic decisions and helps them decide what types of innovation projects to prioritize.

How to use it

Some companies, such as Shell, have highly sophisticated scenario planning teams, and developing scenarios can take months. However, scenario planning can be used in a much more modest manner. A set of scenarios can be created in as little as a few days. The typical steps are as follows.

Collect information about how the world is changing There are numerous 'futurists' who write books and give lectures about the major trends shaping the world. These trends can be classified as follows:

● Political factors – wars, changes in government, rising nationalism.
● Economic factors – free trade zones, currency fluctuations, recessions.
● Social and demographic factors – ageing population, attitudes to privacy, consumerism.
● Technological factors – 3D computing, mobile technology, driverless cars.

The first step in scenario planning is to gather as much information as possible about these types of trends, and then consider how they apply to your industry. Gathering a group of colleagues to brainstorm about how these trends might play out can help you understand their secondorder consequences.

Divide the trends into two categories As you examine these trends and consider how they might interact with one another, you will realize that it is impossible to predict everything. An increased trade deficit, for example, may cause an economic recession, which in turn creates unemployment and reduces domestic production. As a result, it is useful to divide your discussion into two categories: ● Predetermined factors – things that we know will happen. For example, it is predetermined that there will be an ageing population in the developed countries of the world.
● Uncertainties – things that may happen. We don’t know for sure whether China will remain stable or whether driverless cars will become accepted.

Identify and describe the scenarios The predetermined factors can be set aside for the time being – they should be considered in your strategic plan, but they aren't necessary for the next step in the scenario development process. So concentrate on the uncertainties you've created and identify the ones that appear to be the most critical in terms of your industry's future development. For example, if you work in the IT sector, one key uncertainty is the extent to which new technologies are adopted by the population, and another is the extent to which power remains centralized in your countries of operation (see the figure below).

You can identify four possible scenarios by putting these two most critical uncertainties on a 22 matrix. You should then name each of these scenarios (see the hypothetical example below) and briefly describe what each one means for your industry and, in particular, your firm.

scenario planning

Apply the scenarios in your strategic planning process The scenarios can be used for a variety of purposes. For starters, they are an excellent way to discuss the future with the firm's top executives as well as other stakeholders. Most people have a 'default' future in mind that is represented by one of the boxes in the matrix, and by exposing them to the alternative scenarios, they become aware of their own assumptions.

Second, the scenarios should be used more formally to ensure that you are making sound future decisions. One scenario for Shell could be that all future oil reserves are owned by the governments of the countries where they are discovered. This means that Shell cannot expect to own oil reserves and must instead become a provider of technical expertise to countries like Venezuela or Nigeria. Shell's strategy would have to be drastically altered, and it would have to invest in a slightly different set of capabilities than it currently has.

Top practical tip

Identifying the key uncertainties in your business environment is the most difficult part of the scenario planning process. It is relatively simple to generate a long list of trends, but the real challenge is determining which of these trends are both critical to your industry's future success and highly uncertain. So, if you use the process described above, make sure to allow enough time to experiment with various alternatives here, so that the scenarios you generate are the most revealing.

Top pitfall

For scenario planning to be effective, it must be properly integrated into your organization's decision-making process at the top. Many businesses have conducted careful scenario planning exercises, only to have the results ignored by those at the top.

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