Overcoming Obstacles to Effective Scenario Planning
Scenario planning can broaden the mind but can fall prey to the mind’s inner workings. Here’s how to get more out of planning efforts.
October 2015 | by David Delaney
When scenario planning has worked well, it has proved enormously useful to a wide range of organizations as a tool for making decisions under uncertainty. First popularized by Shell in the early 1970s, the approach should be a natural complement to other ways of developing strategy—especially when executives are as concerned about geopolitical dynamics as many are today. It would probably be more widely used if it hadn’t been such a disappointment to many executives.
That scenario planning often underdelivers, in our observation, can be a simple matter of insufficient experience. Companies that infrequently use the approach lack the organizational muscle memory to do it right. Managers who are familiar with it assume they can just delegate it to subordinates. Those who are new to it can get caught up in the details, focusing on the assumptions behind sensitivity analyses, for example, without stopping to think about whether the uncertainties they’re testing are the most important ones. Furthermore, in our experience, scenario planning can be hampered by the same deep-seated cognitive biases that it should be used to address, such as anchoring, neglecting low-probability events, or overconfidence.
Fortunately, an understanding of how such biases undermine scenario planning can mitigate their impact on decision making generally, and improve the effectiveness of scenario planning itself.
Combat Overconfidence and Excessive Optimism
Once scenarios are defined, decision makers turn their attention to identifying the risks and opportunities that each scenario represents and compare them with those of the current business plan. At this point in the process, they will develop a new portfolio of potential strategic actions and contingency plans—as well as a clear understanding of the organizational, operational, and financial requirements of each.
Countless business initiatives fail because executives underestimate uncertainty and the chances of failure—and instead move directly to action. Many organizations reinforce this kind of behavior by rewarding managers who speak confidently about their plans more generously than managers who point out how things might go wrong. Overoptimism and overconfidence lead to projects that run over budget or time, to mergers and acquisitions that fall short of estimated cost and revenue synergies, and to business plans with unreasonable growth expectations.
Overoptimism and overconfidence can be countered by scenario planning but can also infect it. To stay on the right track, managers should avoid the temptation to choose the scenarios they deem most likely and to focus planning efforts solely on them. A good reality check is whether your scenario planning forces executives to consider unpalatable though plausible scenarios.
In the early 2010s, for instance, one energy company sought to assess the implications of oil and gas prices in North America for the company’s portfolio of projects and investments. Of the pricing scenarios that managers created, one significantly challenged the attractiveness of several major business initiatives. The intense debate that ensued highlighted a number of important issues and turned out to be a dress rehearsal for challenges the company and the industry would face in the coming years. Evaluating the portfolio against all scenarios, good and bad, also made it clear that some initiatives would yield returns only in the most optimistic case. The company decided to put them on hold.
Initiatives were further evaluated by two other criteria. The first was their “optionality”: how easy they would be to scale up or down. The second was the flexibility of the timelines—influenced, for example, by how much equity the company held in each initiative. The resulting portfolio contained no-regrets moves (projects or investments financially sound under all scenarios), real options (which required lower up-front investments but could be scaled up when the time was right), and big bets (demanding a large up-front investment to reserve the company’s right to play in the space in the future). Such a portfolio avoids favoring what seems to be the most likely scenario, while allowing the organization to place calculated choices, depending on how the market evolves.