Chapter 20
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.
When to use it
- To help you understand how the business world is changing.
- To identify specific threats and opportunities.
- To adjust your strategy so that you are prepared for whatever might happen in the future.
Origins
The oil company Royal Dutch Shell was the inventor of scenario planning. The idea originated from the military world. In the aftermath of the Second World War, a group led by Herman Kahn at the Rand Corporation started developing ‘scenarios’ about the possible future conflicts that might take place. His ideas were then picked up by a team at Shell in the late 1960s, led by Ted Newland and Pierre Wack.
By 1972, the scenario planning team had put together six scenarios, focusing on the price of oil and also the likely future behaviour of oil producers, consumers and national governments. When Shell’s top management saw these scenarios, they realised how different the world might look if, for example, oil prices were to shoot up. So they committed to using scenario planning as a formal part of their overall strategic planning process.
The first oil crisis hit in 1973, with the formation of OPEC in the Middle East and dramatic increases in oil price. None of Shell’s competitors was prepared for this situation, whereas Shell had had some forewarning. This event underlined the power of scenario planning, and the methodology was quickly adopted by many large companies.
What it is
Making sense of the future is always challenging. One approach is to look at major trends (such as rising population or decreasing oil reserves) and to extrapolate from them. However, this approach fails to recognise that major discontinuities will sometimes occur (for example, a new technology for oil drilling or a political revolution in China), or that there are complex interactions between trends.
Scenario planning overcomes these uncertainties by explicitly acknowledging that there are many possible futures. A smart approach to planning does not assume that the world will work in a certain way ten years from now. Instead, it identifies two or three likely scenarios, and examines the assumptions underlying each one. This helps the firm to make the right investments. For example, a company such as Shell has to keep in mind the possibility that oil reserves may run dry at some point, which might mean making investments into alternative sources of energy such as wind or biofuels.
An effective scenario-planning process doesn’t just paint a picture of how the world might look in the future, it also shapes the strategic decisions made by the firm and it helps them decide what sort of innovation projects to prioritise.
How to use it
Some firms, including Shell, have highly sophisticated scenario-planning teams, and the process for developing scenarios can take many months. However, you can also use scenario planning in a far more modest way. A set of scenarios can be developed in as little as a couple of days. Here are the typical steps involved.
Collect information about how the world is changing
There are many ‘futurists’ out there who write books and give lectures about the major trends that are shaping the world. These trends can be usefully categorised 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 task in scenario planning is to gather as much information about these sorts of trends as possible, and then to think about how these are relevant for your industry. It is often useful to gather a group of colleagues together to brainstorm about how these trends might play out, so that you can understand their second-order consequences.
Divide the trends into two categories
As you analyse these trends, and you think about how they might interact with each other, you will realise that it is impossible to foresee everything. For instance, an increased trade deficit may trigger an economic recession, which in turn creates unemployment and reduces domestic production. It is therefore useful to divide what you discuss 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 now – they should of course be factored into your strategic plan, but they aren’t important to the next step of the scenario development process. So focus on the uncertainties you have developed, and from that list identify what seem to be the most critical ones in terms of the future development of your industry. For example, if you work in the IT sector, the extent of adoption of new technologies by the population is one key uncertainty, and the extent to which power continues to be centralised in your countries of operation might be another (see the figure below).
By placing these two most-critical uncertainties onto a 2×2 matrix, you can identify four possible scenarios. You should then give each of these scenarios a name (see the hypothetical example below), and you should describe briefly what each one means for your industry and for your firm in particular.
Apply the scenarios in your strategic planning process
The scenarios are useful for many things. Firstly, they are a good way of discussing the future with the top executives in the firm and with other stakeholders as well. Typically, most people will have a ‘default’ future in mind that sits in one box of the matrix, and by exposing them to the alternative scenarios they become aware of their own assumptions.
Secondly, the scenarios should be used in a more formal way to ensure that you are making the right decisions about the future. For example, one scenario for Shell might be that all future oil reserves are owned by the governments of the countries in which they are found. This would mean that Shell cannot expect to own oil reserves itself, and instead it has to become a provider of technical expertise to countries such as Venezuela or Nigeria. Shell would need to alter its strategy considerably, and it would require investment in a somewhat different set of capabilities to those it has today.
Top practical tip
The most difficult part of the scenario-planning process is identifying the key uncertainties in your business environment. It is relatively easy to draw up a long list of trends, but the really important step is figuring out which of these trends are both critical to the future success of your industry and highly uncertain. So if you are using the process described above, make sure to allow enough time to try out various alternatives here, so that the scenarios you come up with are the most revealing.
Top pitfall
For scenario planning to be useful, it has to be properly integrated into the decision-making process at the top of your organisation. There are many firms that have conducted careful scenario-planning exercises, only for the results to be ignored by those at the top.
Further reading
Schoemaker, P.J.H. (1995) ‘Scenario planning: A tool for strategic thinking’, Sloan Management Review, 36(2): 25–40.
Schwartz, P. (1996) The Art of the Long View: Paths to strategic insight for yourself and your company. London: Random House.
Wack, P. (1985) ‘Scenarios: Shooting the rapids – how medium-term analysis illuminated the power of scenarios for Shell management’, Harvard Business Review, 63(6): 139–150.