As its name suggests, scenario analysis is a technique used in a business or non-business environment in order to predict future outcomes based on current situations and potential events. In other words, it is a method for estimating what will happen in the future. By having an idea what awaits you in both the short-term and long-term future, you will be much more prepared which will in turn lead to greater performance and greater customer satisfaction.
Scenario analysis can be used anywhere. It can be used within an individual level, a team level or within an international company with several business units. It can also be used within departments or sub-departments.
Best-case scenario vs Worst-case scenario
Often, managers will start by evaluating the best-case and worst-case scenario. In other words, these are the future outcomes of the portfolio if all goes right vs if all goes wrong. By identifying these potential, yet unlikely, scenarios a company can plan for the best course of action if random events are in their favor, while also anticipating problems and losses in the case that the situation turns unfavorable. One method that is often employed to evaluate the worst-case scenario is stress testing. It is mainly used in the financial industry in order to assess investment risk against potential situations using a computer simulation technique.
This technique does not stick to the best and worst case scenarios only, and it instead considers the potential outcomes of several possible scenarios. By having several what-if scenarios in place, a company will be more prepared and agile when that time comes. When identifying the scenarios to be used, you need to first consider the probability of each scenario as well as the impact of the scenario on your business. You should leave out any scenarios that are not relevant or have a minor impact on your company. This way you can clear the clutter; leaving behind only what matters.
Benefits of scenario analysis
By having an idea of how your company will react to different events or situations, you put yourself one step ahead of the competition. Implementing scenario analysis can yield many benefits to your company, including:
- Identifies causality
- Stimulates innovative thinking and stretching beyond traditional techniques
- Improves long-term planning
- Reduces risk by leveraging change to your advantage
- Fosters adaptability and dynamic planning
- Supports benchmarking
- Simple and easy to do
- Simplifies complex interactions
- Takes into account several factors, including external factors within the microenvironment.
Yet, scenario analysis is subject to some limitations. The primary ones are:
- Inaccurate data quality that affects the correctness and reliability of the final result
- Biased results due to human factors. A specialized team must be employed in order to avoid such situations.
- Constant revision and refinement is needed in order for the analysis to stay up-to-date.
- Conducting scenario analysis on a regular basis may burden your company with an extra cost on the long-term.