now, no signup required!
What does it take a business to stay ahead of its competition or survive devastating economic storms? Executives should be prepared with answers for such hypothetical questions because they never know when new legislation is passed, making production expensive or the price of energy skyrocketing. Problem analysis is key to maintaining and even maximizing profit in the event of economic uncertainty.
With scenario analysis, organizations can anticipate and plan for unexpected geopolitical, technological and economic challenges. It’s nothing new but now the availability of simulation software allows organizations to model environments and to evaluate potential outcomes, which makes it one of the components among business analysis techniques. But above all, technology makes the processes much quicker.
If we delve deep into the meaning of scenario analysis we would see that it revolves around uncertainty. The process is a powerful way of navigating uncertainties of the future. It analyzes potential business impacts that may occur in the future and considers possible outcomes. Managers can explore a range of possible future events, whether it’s economic slowdown, natural disaster, opening new offices or expanding a product line.
We’ll discuss scenario analysis meaning, its types, benefits and an example of scenario analysis.
What Is Scenario Analysis?
Scenario analysis is a process that helps businesses examine and evaluate possible scenarios or events that can occur in the future and predict possible outcomes. It subsequently aids in preparing necessary actions and developing contingency plans. The process can be used to estimate or predict changes that the cash flow or business may experience due to the impact of favorable or unfavorable events. It’s crucial for anticipating potential losses and profits. Simply saying, it’s a method to estimate the value of a portfolio after a certain time period, considering key changes in the future.
Businesses can benefit from it as it helps to:
- Predict the impact of an economic slowdown
- Evaluate the impact on revenue and profitability if prices of raw materials rise
- Calculate how much revenue a new product line could generate
- Analyze the unexpected impact on the business due to newer competition
- Devise a plan of action for both favorable and unfavorable conditions
Instead of predicting a single outcome, scenario analysis attempts to examine a spectrum of various potential outcomes and situations.
Types Of Scenario Analysis
Managers have to generate different scenarios for the economy, industry and business. These scenarios include assumptions such as interest rates, product prices, operating costs, customer metrics and other driving factors of the business. Depending on the various factors, we see three main types of scenario analysis:
1. Base Case Scenario
Based on currently accepted assumptions and management, this is the average scenario. For example, if we calculate the net present value, tax rate, discount rate and cash flow, growth rate are the most likely rates to be used.
2. Worst Case Scenario
Worst case scenario considers severe or serious outcomes that may occur during an event. For example, to calculate the net present value we have to deduct the highest expected tax rate or possible cash flow growth rate and consider the highest possible discount rate.
3. Best Case Scenario
This is the ideal scenario for any business. Management almost always acts to achieve such objectives. In this case, to calculate the net present value, the lowest possible discount rate, the lowest possible tax rate and the highest possible growth rate will be applicable. (Adipex)
Today, managers must conduct multiple kinds of scenario analysis to consider every possible scenario using different sets of assumptions. This tradeoff requires more analyzing effort but is essential to make smarter decisions.
Scenario Analysis Example: SHELL
Due to fluctuations in global oil supplies, Shell Oil started using scenario analysis to analyze and respond to changes. Let’s see how they apply this model today:
1. Energy Pathway In Germany
Shell tried understanding specific energy scenarios in Germany and how they could evolve, painting a clear picture of opportunities and challenges. They progressed in power generation and are now focusing on heating and mobility. Shell identified the drivers of cross-sector energy transformation and developed two possible scenarios for energy transition. These scenarios highlight how future energy pathways can evolve and help the government and society to support key energy decisions.
2. Response To AIDS In Africa
Shell develops scenarios to advise public bodies, governments and institutions to help them respond to the AIDS epidemic and improve community health in general. They developed scenarios to identify ways that the virus spreads and could spread in the future. These scenarios act as tools to guide leaders to respond to the epidemic and create the best outcome for Africa.
Managers and executives must rely on perspective analytics platforms to create models and run scenarios in dynamic industries.
There are several adaptable analytics platforms that managers must be aware of to determine threats and opportunities to make data-driven decisions and gain a competitive advantage, without the help of experts. Harappa’s Critical Thinking pathway is designed to make you actively engage in cognitively challenging tasks, think objectively and solve problems related to complex scenarios. Continuously seek, absorb and interpret newer information regularly. Sign up today and learn to work in complex and rapidly evolving environments.
