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We make decisions every day, for business or personal interest. Whether we are planning for a two-year product development and rollout or a home improvement project, the strategic thinking we apply on them is very similar. First, we have a problem with a lot of unknowns, then imagine the possible futures, what could be done and what could go wrong, finally develop strategies to achieve the best results in a range of presumed conditions. This is the foundation of scenario planning.
Scenario planning is a powerful and effective tool for complex decision making in uncertain times. It has been widely adopted by large corporations for strategic planning. Some companies also use simulations to assist with training and field deployment. Depending on the level of complexity, it could take up to 2-3 months to complete a scenario planning exercise factoring in the time spent on research and meeting with all stakeholders.
The good news is that, for most small businesses, the analysis can be done much faster because there are fewer hoops to jump through in a 10-employee organization than a 1000-employee organization. Without having to invest in scenario planning software, you can “craft” multiple scenarios with a systemic approach in an MS Excel sheet or Macbook Numbers or whatever tools that allow you to formulate and build logical models. I will illustrate this with a case study later.
A few essentials for a sound scenario planning exercise.
- Be clear and specific about the problem.
Research the competitive landscape, consumer trends, policy changes, economic shifts, etc. to put the problem in context. Understand your business’ financial health and how it currently operates. The more information relevant to the problem you can collect, the richer the model can be, the deeper the insights you can draw from it. Then synthesize the story. This is a process of diverging and converging.
- Define assumptions/drivers for change, constraints, and key outcomes.
In uncertain circumstances, we’re almost certain that some important factors are going to change but unsure how they are to change. These are the drivers. If we make our best guess at them, these become assumptions. They are very useful and practical for formulation and modeling later.
A great example of a driver for change is Covid-19. We can then make the assumption that vaccines will be available by the following year.
Constraints are the limiting factors that could lead the scenarios to certain directions or shape them in certain ways that are unique for your business. For example, I can’t afford to increase staff, therefore, I can only open 5 hours versus 8 hours a day after reopening.
Key outcomes are the results of the scenarios. In order to compare the scenarios, we need to design some commonly measurable metrics. For example, revenue, customer acquisition, return of investment (ROI), etc. It’s up to you to choose the metrics that matter the most to your business.
- Formulation and modeling.
The formulation is a product of systemic thinking. It reflects how various factors such as drivers, assumptions, and constraints are connected in a sequential and logical way that leads to potential outcomes. Modeling further deals with larger datasets and more complex scenarios.
- Create 2-3 key scenarios.
Among the hundreds of possible scenarios, not all of them have the same weight. Choose the top 2-3 scenarios, then dive deeper and further investigate the implications. The 2-3 scenarios ideally should represent the majority of the probabilities to your best knowledge. Some prefer to develop three scenarios, i.e. average case, best case, and worst case, assuming all other scenarios fall in the range between the best and worst cases. Whichever method you choose, narrow down to the number of cases that your resources can support for further investigation.
- Select one best scenario.
Prioritizing one scenario and allocating your resources to take action is the simplest and most effective way to combat complex issues. With limited resources, focusing one scenario increases chances of success as opposed to being spread out too thin on multiple scenarios. As new information emerges, you can make adjustments to the scenario and refocus. The other scenarios being studied earlier offer insight into the range of possibilities that help inform the adjustments.
Case Study – Sarah’s Cake Studio
Sarah’s Cake Studio has an average monthly revenue of $10,000 prior to Covid-19. The studio was closed for three months during the lockdown. During this time, Sarah did some research and decided to invest in a web app that will allow her customers to book and pay for the cakes online. If Sarah hires a developer to build her own branded webapp, it will cost 25,000 and an ongoing $400 monthly maintenance fee. Sarah decides to finance the $25,000 with a small business loan, which requires a monthly repayment of $1,000 in addition to her existing loan repayment of $1,000 per month. The webapp will be delivered in three months. If Sarah creates an e-store on Shopify, it will cost her $2,000 to hire a freelancer for the initial setup and $400 ongoing monthly fee paid to Shopify.
To understand the risk and return of the investment, Sarah conducted a scenario analysis by factoring in the uncertainty after reopening. She narrowed down to three scenarios.
Scenario 1 – Continue in-store operation after reopening without investing in a webapp.
Scenario 2 – Build a webapp during the downtime then move all sales online after reopening in July.
Scenario 3 – Build a webapp during the downtime then launch a hybrid model offering both online and in-store purchases.
- Vaccines will be available in 2021. Operations will resume prior to Covid-19 conditions in 2022.
- For all three scenarios, in-store monthly revenue drops from $10,000 to $3,000 in 2020 and 2021, to $6,000 in 2022 after reopening in July 2020.
- In Scenario 2, the revenue generated from Sarah’s own webapp will gradually ramp up to $5,000 per month in 2020 and 2021, to $8,000 in 2022.
- In Scenario 3, the Shopify e-store will generate $2,000 per month in addition to the in-store revenue.
- The store must provide hand sanitizer and masks to customers.
- The store must conduct frequent cleaning during stage 2 & 3 reopening.
Key outcome metrics:
- Annual revenue. Only six months from July to December are accounted for in 2020.
- Three-year total net income, from July 2020 to December 2022.
After assessing the short term and long term impact on her business, Sarah decided to proceed with Scenario 3. She will implement a digital platform providing her customers with more convenience and opening up new opportunities while she continues to serve them in the store.
Other useful strategic planning tools
- Porter’s Five Forces analysis, which addresses industry attractiveness and rivalry through the bargaining power of buyers and suppliers and the threat of substitute products and new market entrants.
- SWOT analysis, which addresses internal strengths and weaknesses relative to the external opportunities and threats.
- PEST analysis, which covers the remote external environment elements such as political, economic, social and technological (PESTLE adds legal/regulatory and ecological/environmental).
- Balanced Scorecard, which creates a systematic framework for measuring and controlling strategy.
Thank you to those who have inspired and enlightened me to find simplicity out of complexity.
– Sarah Shu, CEO & Co-founder of Thrive Insights Inc.