Scenario planning can be more easy than you might expect. Big corporations may have entire finance teams dedicated to the process, but we make it easy for small businesses to forecast profitability under a wide range of hypotheticals.
This guide to scenario planning types gives you a broad understanding of landscape. In reality, as a small business, you don’t need to understand all the different scenario planning frameworks. You just need a simple yet robust software built to simplify small business scenario planning. But, if you want to understand the types of scenario planning used by large corporations, read on.
What is a business scenario?
A business scenario is a thorough description of a business problem or issue. The scenario could be describing a current situation, or a hypothetical one. For purposes of strategic management and planning, a business owner is typically modeling a hypothetical future scenario.
When engaging in scenario development, strategists assess the economic and geopolitical climate, as well as their own competitive landscape, and ask what-if questions such as the following:
- What if interest rates rise by 3% over the next year?
- What if the job market gets more competitive, making it more difficult to hire and retain good people?
- What if a natural disaster shuts down my business for 3 weeks?
- What if I invest in an upskilling program for my employees?
By asking these questions, business owners can craft scenarios that give them a glimpse into how they might navigate these hypotheticals. They can then use the insights gained to build more resilient companies.
The importance of scenario planning
Scenario planning is a type of performance management, a way to model potential futures and plan accordingly. As a key part of corporate strategy, it allows executives and finance teams to see how different variables would affect a company. For example, you could model the impact to your profitability if you raise prices by 9%, or if your cost of goods sold increases by 13%. You could model the impact on your business of an economic downturn, a pandemic, or rising interest rates.
The following two questions are associated with scenario planning:
- What could potentially occur? This is the scenario itself.
- What would be the impact on my business if it did occur? This often involves looking at “best case,” “most likely,” and “worst case” scenarios.
Based on the insights gained from modeling multiple scenarios, you can create a plan to navigate them and steer your company to greater profitability and away from financial ruin.
Types of scenario planning
Traditionally, there are four main approaches to scenario planning and forecasting. For the average small business, an understanding and mastery of all four is unnecessary.
Profit Frog blends the most valuable aspects of each scenario planning type to allow business owners to easily and decisively navigate uncertainty.
Normative scenarios
Normative scenarios describe an achievable, most preferred, end state. This type of planning is geared towards long-term corporate goals. Normative scenarios are usually combined with other types of scenario planning, as they focus on the end goal rather than how to achieve it.
The downside of normative scenarios is that they have no “objective” mechanisms. Normative scenarios focus on articulating the “what” while putting very little focus on the “hows” or “whys.”
Quantitative scenarios
Quantitative scenarios look at scenario planning through the lens of financial modeling. These scenarios examine the potential financial implications of best-case, worst-case, and other hypothetical scenarios.
Quantitative models are based on independent variables. Even though quantitative scenarios are great for short-term forecasting, they are less reliable when complexity increases. Quantitative scenarios lack transparency which is why they can give flawed assumptions resulting in unreliable models.
Operational scenarios
Operational scenarios are the most common form of scenario planning. They focus on the immediate impact of a specific event and provide short-term strategies. Operational scenarios look at all potential outcomes of a certain decision and how they can influence the business.
Operational scenarios usually operate within businesses’ “comfort zone.” Operational scenarios can’t cover most uncertainties that are required when planning for future scenarios. Scenarios like these don’t challenge traditional assumptions about how the industry works
Strategic management scenarios
Strategic management scenarios examine your company’s environment. They look at the broad picture, including the economy in your area and how your customers are likely to think and behave.
Scenarios in strategic management modeling are often difficult to understand. Strategic management scenarios are better for larger companies as they require a larger initial investment and significant consulting help.
Simplified scenario planning for small businesses
With Profit Frog, you don’t need to have previous knowledge of the scenario planning process to get the benefits. Simply follow the prompts in our software and model different scenarios for your company.
What are the 5 steps of the scenario planning process?
Traditionally, the 5 steps of scenario planning looked like the following (Profit Frog simplifies these):
- Identify trends or decisions needing to be made
- Come up with plausible scenarios involving those trends or decisions
- Develop a scenario planning template
- Create one or more scenarios
- Evaluate your scenarios
With Profit Frog, the process is more straightforward:
- Identify scenarios you want to model
- Input actuals (data about your business) into Profit Frog
- Adjust variables (costs, pricing, or other drivers of profit) dynamically to see how they influence scenarios
- Create a business plan and update it dynamically as conditions change
Implementing scenario planning helps you make decisions that limit downside and expose you to greater upside.
Scenario planning FAQ
What is the difference between strategic planning and scenario planning?
Strategic planning and scenario planning share a lot in common, but differ in the following respects:
- Scenario planning assumes a dynamic, chaotic future and helps you plot the course to maximum profitability through all the unknowns
- Strategic planning processes assume a known future outcome and strategize how to get there
In other words, strategic planning is a more static process and is disrupted by variability, whereas scenario planning is designed to navigate variability.
Scenario planning can be applied to all business types.
How to create a scenario planning project?
Here’s the fastest, most efficient way for small businesses to create one or more scenario plans:
- Identify basic scenarios you want to model
- Input actuals (data about your business) into Profit Frog
- Adjust variables (costs, pricing, or other drivers of profit) dynamically to see how they influence scenarios
- Create a business plan and update it dynamically as conditions change
Scenario planning project example:
A scenario is a situation or sequence of events. We are modeling different sequences or series of events to see what will happen to a business, based on a set of assumptions in each scenario.
Say, for example, you sell cold-pressed juices and other wellness snacks through various e-commerce channels. You are deciding the next step for our business, and you want to model three different scenarios before deciding how to proceed forward. The scenarios are:
- Expanding from e-commerce to selling in retail stores such as Target, Kroger, Whole Foods, and Trader Joe’s
- Adding a new product line of nutritional juices to be sold within existing e-commerce channels
- Opening your own retail store to sell your current products
A good scenario planning template–or scenario planning tool such as Profit Frog–will allow you to model all three of these decisions. Not only will you be able to model each scenario, but you’ll be able to do so under a variety of hypotheticals.
- Which has the better outcome if labor costs increase significantly? Or if there is a labor shortage?
- Which has the better outcome if prices of raw materials increase significantly?
- Which has the better outcome if commercial real estate prices drop?
- Which has the better outcome if you invest heavily in brand positioning?
What are the advantages and disadvantages of scenario planning?
Doing scenario planning exercises helps you navigate your company to more profitable avenues. It also helps to mitigate risk: by identifying the biggest threats to future profitability, you can proactively implement strategies to de-risk your company.
Advantages
- Be strategically and financially prepared for a worst-case scenario and mitigate its potential impact
- Learn where to allocate your resources and when to back down from an investment
- Identify key issues and turn them into gain
- Identify positive and negative profitability factors in your business operations
- Recognize and seize amazing opportunities
- Learn how to mitigate the risk to your business of external factors outside your control
- Speed up the planning process while making better decisions
- Gain confidence in your decision-making skills
Disadvantages
The biggest disadvantage of scenario planning has traditionally been the time and resources it consumes. Before the advent of scenario planning tools, modeling different hypotheticals took a huge amount of time.
Modeling scenarios in Microsoft Excel, for example—even with a pristine scenario planning template—is a difficult process for all but the most proficient Excel users.
These days, a wealth of scenario-planning tools have made the process more achievable for regular folks.
Profit Frog’s scenario planning software is targeted at small businesses. We take away a lot of the complexity that some of our competitors include—many of them focus on serving funded startups with complicated CAP tables and shareholders—and give small businesses exactly the features they need…and none that they don’t.
How to use scenario planning in situations caused by the Covid-19 pandemic?
In a world remade by the pandemic, every business needs to invest in financial, strategic, and operational scenario planning. Profit Frog helps you model profitability across all types of scenarios, including disruptions caused by a natural disaster, pandemic, supply chain issues, or other events.
What is scenario analysis?
Scenario analysis is another term for scenario planning: the process of comparing various scenarios against each other. It allows you to plan, in a fast-paced world full of critical uncertainty, what you will do based on different potentialities. Companies often use scenario analysis templates in their forecasting process.
Profit Frog offers scenario analysis software crafted around the needs of everyday entrepreneurs and owners of small businesses. We take away the complexity and give you powerful tools to do forecasting, analysis, and financial reporting.
What is CapEx planning?
CapEx tells business owners how much a company is investing in their existing and future assets. CapEx budgeting helps businesses
Capital expenses tell you how much a company is investing in existing and future assets to maintain and grow the business.
What does break-even analysis depend on?
The break-even analysis depends on three assumptions:
- Average per-unit cost
- Monthly fixed costs
- Average per-unit sales price
How do you craft scenarios?
The first step of writing a scenario plan is brainstorming the different scenarios. Then, write down what information you’ll need to develop a model for each scenario. This requires an understanding of what assumptions (inputs), calculations, and outputs will be needed for your scenario.
- The cost of rent for the location
- The cost and number of employees you need for the store
- What inventory you will need in the store
- How much revenue you can assume to make each month
- How much will you spend on marketing and advertising
In addition to the inputs above, you also need to think about factors that you cannot assign financial input and how they impact the decision.
What are the 4 perspectives of a balanced scorecard?
The following perspectives are the fundamental areas that a balanced scorecard focuses on:
- Customer perspective
- Financial perspective
- Organizational capacity perspective
- Internal business processes perspective
What are the 4 components of a data warehouse?
A data warehouse has four main components:
- Metadata
- Access tools
- A central database
- Exact, transform, load tools (ETL)
What is contingency planning?
Contingency planning is a course of action that is designed to help businesses create effective responses for future events or incidents that could potentially happen.
What is analysis of variance?
Variance analysis helps businesses manage operational expenses, production as well as products, by monitoring actual costs vs planned costs. Creating effective analyses can help your business improve its operations. Planning and analysis will help understand and improve business costs and performances.
What is the difference between scenario planning and business continuity planning?
Business continuity planning can be considered a subset of scenario planning: an impact analysis focused on the hypothetical loss of a key executive. Scenario planning—such as the type Profit Frog enables—emphasizes risks and opportunities across the spectrum of business operations. Scenario planning isn’t focused on business continuity per se, as leadership disruption is one small subset of hypotheticals that a business owner needs to focus on.
What are the best practices for scenario modeling?
These are four best practices for financial scenario modeling:
- Automate as much as your can
- Choose key variables carefully
- Focus on the right level of data granularity
- Use as many data sources as possible
