If your organization is experiencing uncertainty in business outcomes like fluctuating profitability, it is likely that this is a result from exposure to increasingly frequent and powerful volatile conditions in the external environment.
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Fortunately, present-day predictive modelling techniques allow us to cope with this uncertainty to some extent. For decades we have been able to predict business outcomes based on statistical probability. Organizations in a variety of industries have effectively leveraged these statistical techniques for short-term business planning. However, if the time-horizon of what is perceived as the ‘foreseeable future’ increases, we need to accept that extrapolation of the past no longer allows us to predict the future. The strategic planning process then requires an instrument more capable than producing a probability-statistic for a single scenario to unfold in the future.
Volatility and uncertainty affecting financial agendas of the organizations is not new. However, the ability of the organization to be prepared, responsive and agile under these conditions is becoming a crucial factor of success. How is this achieved in practice? Scenario-based planning is one of the techniques enabling organizations to respond to uncertainty and introduce agility in the financial planning process. Next, we'll go into greater detail on the following aspects of scenario-based planning:
- Accepting multiple scenarios possible to unfold in the future increases the reliability of decision-making. Instead of analyzing new assumptions, refining forecasts and explaining differences against initial budget, the company just refers to the relevant scenario and focuses on achievement of its objectives
- A driver-based approach to planning and sensitivity analysis techniques are very complementary to scenario-based planning. This will allow your company to refine assumptions and obtain the most relevant integrated view in real time
- Financial planning solutions are more and more considered as enablers that offer wider capabilities on the way towards operational excellence in financial processes, and high-quality support of the business value growth
In the following sections we will take a closer look on what scenario-based planning is, why it is important, how it works, what else you need to know before implementation, and who is best positioned to drive it.
WHAT? – Uncertainty Is Here to Stay
Scenario-based planning assumes multiple scenarios feasible to unfold. It allows your organization to react with speed in taking advantage of new opportunities, and effectively manage risk in an uncertain and volatile world. Traditionally, organizations operating in capital-intensive industries, such as Energy and Aerospace, are in demand of strategic planning instruments. For example, a prominent Dutch oil and gas organization has developed a robust framework to address uncertainty with a time-horizon approaching 2050, allowing them to effectively manage their capital projects. Today, increasing uncertainty has also triggered other sectors to adopt scenario-based planning. For example, the banking industry, seeking to mitigate competitive actions affecting profit margins; exchange-rates affecting treasury management and hedging strategies; and market volatility affecting risk management.
WHY? – Multiple Scenarios to Be Considered
Scenario-based planning has become increasingly relevant to a magnitude of organizations over the recent years. The most significant driver of this demand is the unconventionally high level of volatility, as external economic and political forces are impacting industries across the globe. Nevertheless scenario based planning is currently not common practice for organizations in their planning and control cycle; research indicates that 80% of the organizations set targets in relation to historical performance instead of future scenarios, which is a suboptimal baseline even in a less volatile external environment.
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" 80% of the organizations set targets in relation to historical performance instead of future scenarios"
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HOW? – An Iterative Process of Scenario Revision
The developed scenario-based planning model can be leveraged to support several domains of enterprise performance management. It allows your organization to develop rational action-plans to achieve targets, and execute corrective actions to close performance-gaps intermediately. Organizations adopting scenario-based planning in their strategic decision-making process are exploring the best chance on success through an iterative decision-making process that explicitly addresses risk. This is how it works:
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(1) Your organization identifies key factors with material impact on their business. (2) A variety of relevant scenarios that describe a range of potential operating models in different environments is established. (3) Then the most likely scenario to unfold is identified. (4) Your organization develops a strategic plan for the budgeting process, and (5) assesses the impact of each scenario on revenues, margins, cash flows and capital expenditures. (6) The organization establishes tolerance thresholds for the triggers and connects them to scenarios in order to detect when the current baseline-scenario is no longer valid. If so, than an alternative scenario has become material. (7) When triggers are activated, the organization adjusts its tactics in line with the scenario-plan.
WHAT ELSE? – Supporting Techniques and Tooling Considerations
For a successful implementation of scenario-based planning it is crucial for your organization to understand the relationship between key business drivers and the developed scenarios. In practice, revealing and justifying these connections might prove to be one of the biggest challenges in the process of implementation. However, if your organization has already adopted a driver-based approach in the planning process, there is likely to be a strong understanding of how internal and external factors affect the business performance. For example, you will have an understanding of which metrics are affected by a change in exchange rates, raw material costs, labor costs, and so on. In addition, sensitivity analyses might have already revealed to what extent business performance is affected. In scenario-based planning these external factors are the ‘triggers’ that drive the iterative process of scenario review, and organizational steer.
Once the relations between business drivers and scenarios are established, the organization can develop an integrated planning model reflecting these relations. Depending on the organization, the number of parameters and the complexity of identified correlations, an appropriate planning tool can be selected. This provides a platform for management for building scenarios and to evaluate strategic options. A spreadsheet might suffice to manage more simple models, containing a limited level of granularity. For more complex models that anticipate technology disruption and the evolution of competition for example, a specialized and more powerful planning solution will be a required.
WHO? – The CFO as Guardian of the Economic Value Agenda
The role of the CFO has evolved over the years from accountant to guardian of the economic value agenda of the organization. Research indicates that 73% of the CFOs have become more involved in the strategic planning process over the last two years. Supporting the evolving function of the CFO, Accenture guides the integration of industry leading processes and technologies to enable value creation within the organization. In the area of Enterprise Performance Management, Accenture thrives to bring rigor and predictability to the organization by leveraging enabling technologies like SAP BPC, Oracle Hyperion, OneStream, IBM Cognos, Anaplan, Adaptive Insights, Host Analytics, Tidemark, Tagetik, and Board. With this strong focus on the intersection of business strategy and technology, Accenture explores value-creation to drive profitable and sustainable growth.