If you focus on the worst case scenario and it happens, you’ve lived it twice 😉 – Michael J. Fox
People think that scenario analysis is about how the future is going to pan out, but it is about how you make decisions now, in the present moment.
It is the use of alternative stories or narratives, which might be provocative or dramatic, but it helps develop strategy and prapare for what lies ahead. It has helped Shell group (its inventor) to avert the 1973 energy crisis, the severe price shock of 1979, the collapse of the oil market in 1986 and the fall of the Soviet Union amongst others.
Scenario analysis starts with a macro view of your industry, market and customers where you look at the conditions that you are operating on, and how any of it could change.
Here’s a quick scenario analysis framework.
Step 1 | The what-if Identify key uncertainties that can impact your business and extrapolate them into various situations that it can develop into. Use open-ended questions like: Will work from home lead to change in behaviour of consumers? Will restaurants and malls closed for a prolonged time mean a lack of good food? etc.
Step 2 | The four horsemen Bucket them into scenarios that cover the span of plausible outcomes. McKinsey says four buckets are better than three because people almost always pick the middle one if there are three scenarios. You can use creative names to define each scenario
Step 3: The Now what? Craft your responses on how this impacts your revenue, cost, expenses, etc. and how a business case could be developed on the same
Step 4: Trigger Identify trigger points across each scenario. These trigger points are the red flags that would point which scenario is likely to occur.
Step 5: Iterate | The rapidity of events since past 12 months mean we should revisit the scenarios every 4 weeks, identify trigger points, responses, refine assumptions on uncertainities.
Step 6: Embed | them into your valuation Once you have the narrative of scenarios, embed them into your valuation and see how it can impact the value of your company.
With the uncertainty that Covid has introduced and the shift in geo-political, industry and market views, a scenario analysis is a great sandbox to stress-test an existing strategy and make it better. Most importantly, it serves as a framework for better dialogue and also prepares you for a black swan event.