Analysis: Scenario Planning

By Bruce Melzer  |  Posted 06-01-2001

Analysis: Scenario Planning

 

Introduction

It all began one morning in the fall of 1958, when physicist Herman Kahn read an article in the New York Times about the escalating U.S.-Soviet arms race in which Soviet premier Nikita Khrushchev predicted a nuclear holocaust. Over the next few weeks, as Khrushchev continued to dominate the nightly news broadcasts with increasing threats of Communist world domination, Kahn began gathering together teams of experts and encouraging them to develop educated stories about the future, which he called scenarios. Sometimes sitting for hours at a time on the Santa Monica beach near his office at RAND, Kahn and his experts coolly calculated the reality and the costs of nuclear conflict. The result was a series of famous papers and strategy advice to the Pentagon, including the chilling On Thermonuclear War and Thinking About the Unthinkable.

Kahn's early experiments and treatises on scenario planning didn't stop there. His methods of peering into the future helped shape how a generation of Pentagon planners thought about the Cold War—and how a generation of business strategists at companies from Royal/Dutch Shell to Cigna Corp. looked at the future.

The Hudson Institute, founded by Kahn in the early 1960s, is widely recognized as the laboratory for modern-day scenario planning. Indeed, the technique has been used by hundreds of companies, from telecoms such as 3M Technologies and Nokia to retailers like Nordstrom's, to guide strategic decisions, select investments and position themselves to operate in an uncertain world.

But the technique is difficult: It demands intellectual rigor and a clear understanding of its powers and limitations. Yet as CIOs seek to manage the enormous economic and technological uncertainties facing their companies and the technologies they oversee, scenario planning can be invaluable for justifying strategic investments, determining which technologies live and die, and opening the minds of managers to a deeper sense of what the future may bring.

The Shell Game

The Shell Game

Among the first to expand on Kahn's technique and apply it to business planning was the planning unit at Royal Dutch/Shell Group. Since the end of World War II, both the price of oil and the growth in demand had been remarkably stable, and few oil executives had the foresight to imagine that things would ever change. By the late 1960s, Shell had developed a complex forecasting tool called the Unified Planning Machinery, used to predict growth in energy demand and upcoming oil prices. With that information, the company could generate strategies for investment in tankers and refineries as well as trading strategies. For years, growth in demand had cooperated nicely, edging up just ahead of the planners' expectations.

But beginning in the late 1960s, Shell's London-based planning group, led by Ted Newland and Pierre Wack, began generating scenarios that ventured beyond the expected, into political territory that no forecasting mechanisms at the time had accounted for. "Among the futures they imagined was one in which the rising power of Arab governments led to a catastrophic drop in the supply of oil and huge hikes in its price," says Dr. Paul Schoemaker, chairman and CEO of Decision Strategies International, Inc. and research director at the Wharton School's Emerging Technology Program. "Wack and Newland recognized that political logic in addition to economic logic would dictate price." While Shell's upper management found it compelling, the scenario proved difficult to communicate to the company's loosely connected line managers around the globe. At the time, Schoemaker says, supply and demand, in addition to long-term contracts, dictated price in the energy markets, with no exceptions, "so to suggest otherwise at the time was seen as being really out there."

Shell managers, according to Schoemaker, "listened politely to Newland and Wack and then shelved their warnings." But the Arab oil embargo of 1973 forced Shell's managers to revisit them—and to incorporate scenario planning into their regular planning process. As a result, the company reduced the size of its oil tanker fleet—forecasters had accurately predicted an overcapacity in the tanker industry—and entered into longer-term contracts for oil, thereby locking in prices against what scenario planners felt would inevitably be politically-driven spikes. The effort paid off: Shell was better prepared for the oil shocks of 1979 and the subsequent mid-1980s collapse in price.

Typically, scenario planning uses a high-level team to determine the underlying drivers of a business and the fundamental uncertainties—economic, technological, political, social, demographic, environmental—that surround a company and its markets. At best, the process is rigorous, systematic and ongoing. The planning team, enlisted from a variety of departments—planning, IT, finance, human resources—and sometimes from outside the company, begins by identifying the key drivers of the business, along with trends in the industry, the market and the environment as a whole. The team then determines how the various forces interact, and works to understand the sources of uncertainty that will affect the company's future. For example, a key uncertainty might be unreliable energy supplies, which could have large implications for hardware design, centralization of servers or design of networks. By combining the forces and uncertainties in different ways, the team produces several divergent and internally consistent views of how the world might look in two or five or 10 years. Those scenarios are used to aid current strategy and decision making.

The tool is particularly well suited for dealing with major long-term decisions involving a high degree of uncertainty about the future. Will the growth in penetration of the Internet continue at the current pace? Will increased privacy concerns prove a drag on the growth of e-commerce? Will continued tight capital markets significantly slow down the build-out of high-bandwidth networks?

Forecasters Beware

Forecasters Beware

Shell's experience shows that scenario planning can work, but it has pitfalls. Among the most common is the tendency to treat it like forecasting. Forecasting is predicated on a stable past, and suggests a single, predictable future. Forecasters simply take the current trends, tweak them a little and run the numbers out farther into the future, sometimes adding a high and low case just to cover their bets. Deloitte Consulting's Charles Thomas notes that the problem with forecasting is the underlying assumption that the future will look a lot like the present; only the magnitude of the key variables may change.

A company might believe that the market segments in play now will continue basically unchanged for another decade. To build a high or low case, you would construct a forecast by underpopulating and overpopulating a market segment with potential customers, says Thomas. "What you're not going to see," he adds, "is that this political movement is getting started, here's a group of people that has become wealthy overnight because of a bubble in the stock market, and these political sanctions went into effect. And bang, your segment just disappeared completely." Scenario planning might help you prepare for that; extrapolation won't.

For CIOs, scenario planning can provide that more complete picture. It can help them make long-term IT-related decisions, better align IT systems and infrastructure with the company's strategies, achieve buy-in from top management and in-house clients for IT spending, and gain a more authoritative voice in company strategy.

Indeed, some analysts believe scenario planning can be used particularly effectively in just such relatively short-term planning—and that's particularly true now that the rate of change in business has increased so significantly. Consider how deregulation and the Internet have combined to transform the utilities industry, putting a premium on fast-paced energy marketing and trading. Says Amy Oberg, manager of competitive intelligence and future foresight at Enron Corp. in Houston: "The tactical is becoming the strategic because of the compressed time frame."

But don't count on it to generate the numbers needed to build a business case for a technology investment. Although it is rigorous, scenario planning tends to be more qualitative and strategic than quantitative: It can help you choose which path to take, but not how fast you'll get there, or how much it will cost you. And if you're looking for a business case, you'll still need the more traditional return on investment, internal rate of return and other standard tools in the project planning toolbox.

Choose Your Problem

Choose Your Problem

What kinds of problems are best suited for scenario planning? John Parkinson, a strategy consultant at Ernst & Young LLP, suggests two circumstances in which scenario planning is particularly useful. "One is when you're facing a high degree of uncertainty and none of your predictors are being very helpful in showing you what the future is going to be like. Looking at the broadest set of possible outcomes lets you identify common themes or factors that may make a lot of difference," he says. "The other is when all of the trend lines are clearly unsustainable, so that the predictors, though they can tell you things, can't be telling you the truth." When Parkinson and his group were tracking the early stages of commercial activity on the Internet, they began seeing "compound monthly revenue growth rates in the mid-teens," he says. "Revenues by 2003 that were represented by the Net were coming in at 40 times GDP. No way could you say that's going to happen for the next three years." The point: Know when to take your scenarios with a grain of salt.

Utilities, telecom companies, healthcare concerns and other businesses suddenly thrust into either unregulated environments or global marketplaces are prime candidates for scenario planning; indeed, many are turning to it as a safety net against future uncertainties. "If the amount of turmoil in your operating environment is increasing, this is a great tool for you," says Deloitte's Thomas. "If there isn't a lot of turmoil and your marketplace has a lot of clarity about it, you don't need this."

In the face of rapid technological change in the insurance business, Steve Andriole, CTO of insurer Cigna Corp. from 1995 to 1997, turned to scenario planning to determine the impact of the Internet on the medical industry, insurers and the IT needs for each of his company's nine divisions.

"I don't care about technology," Andriole recalls telling each business president. "What I care most about is your business. So help me help you think about your business strategy. And after we have a consensus, then we'll think about the technology investments we need." To win buy-in from the president of each business line, he paid for the scenario consultants.

In 1995, Andriole convened teams of executives from each of Cigna's business units, such as property and casualty, healthcare and investment services, as well as IT managers and IBM consultants. The assignment: Determine the future structure of the industry, identify and understand the competition, then examine the role of technology and the Internet in healthcare.

Starting from sample scenarios developed by IBM, Cigna's team developed its own list of major uncertainties and business driving forces. The resulting four-scenario matrix was based on two key uncertainties that made up the two axes of the grid: the role of technology and the role of the government. In one scenario, called Big Brother, "many of the business processes were defined by extraordinarily complex regulations" involving privacy, patient rights and the Internet-based provision of healthcare, Andriole says. At the opposite extreme was the Wired, Wired World, where the Internet was ubiquitous and everything and everyone was wired together.

Cigna's team developed specific outcomes and assigned probabilities to each scenario. The team was 75 percent sure, for instance, that in the Wired, Wired World, within five years people would use the Internet to pick a primary-care physician, schedule appointments, exchange medical records and perform other healthcare tasks.

Next Cigna asked, "If that's true, what do we have to do to prepare?" recalls Andriole. The team created a prioritized list, complete with cost estimates, of things they'd like to have if the scenarios were true. Adding in costs "forces people to rethink the list," Andriole notes.

Andriole used the results to prepare his strategy for the next budget cycle, won buy-in for the top priorities on his list—network infrastructure and application development—and gained credibility for the vital role of the CIO in the strategy process.

At the same time, Cigna chose not to make the strategic investment in data warehousing and data mining needed to support a significant push into cross-selling. "The expected value of cross-selling didn't justify the investment," says Andriole, "especially since the company was planning to divest some of its business lines, such as personal life insurance."

As successful as the technique can be, scenario planning isn't the magic solution for every strategy problem. In fact, it appears to be losing some of its allure. Since 1993, management consultants Bain & Co., Inc. has surveyed executives to find out which management tools they use most often. Bain's most recent survey shows the usage rate for scenario planning has slipped from 38 percent in 1993 to 30 percent in 2000. "That's a fairly high defection rate," says Darrell Rigby, the Bain director who oversees the study. "I must admit it's a disappointment to me."

In follow-up interviews, Rigby found that executives who abandoned scenario planning said it was just too much effort for the results they got out of it. "What they have often done is to go into extraordinary detail in developing scenarios that were a little far-fetched," Rigby says. Dissatisfied users also "spent too much time going down paths that most of the organization didn't feel was the slightest bit relevant." And, Rigby notes, "there is always an element of waste in planning for contingencies that never occur. After all, 70 percent of scenarios never come to pass."

Says Hugh Courtney, an analyst at McKinsey & Co.: "Most companies have no formal process for embedding the scenario method into corporate strategy, and that's the key." Critical to that effort is avoiding a common pitfall of the process: treating scenario planning as a predictive tool. But using scenario planning to develop strategy presents a thorny logical problem, one conceded by all scenario planners: How do you plan if the scenarios seem to point the company in several directions at once?

One solution, used by British e-business consulting firm International Computers Limited, is diagrammed in the chart on page 39. It suggests an iterative process that generates "critical success factors" for doing business in the kinds of markets resulting from your scenarios. That way, an overarching strategic plan is laid out that prepares the company to respond to a variety of possible futures.

In the end, however, "a planning technique is only as good as the implementation," says Roy Lowrance, vice president of The Boston Consulting Group, Inc.'s North America IT practice. There's a risk that CIOs and others may latch on to scenario planning as the "tool of the hour," bringing to it unrealistic expectations. At the same time, scenario planning, like any new technique, "can capture the mind and get people excited. And if this is the technique that gets people excited, then take advantage of it."

The key value in scenario planning, says Schoemaker, is not to accurately predict the future but rather to start thinking more intelligently about it. "Build in more flexibility, and then your own creativity becomes the only limit on your ability to exploit the future," Schoemaker says. Easier said than done, perhaps, but in today's uncertain world, scenario planning can be a check on strategic planning that many companies can no longer afford to ignore.

Bruce Melzer, a senior editor at NPR Online, is the former business editor at ABCNEWS.com. Comments on this story can be sent to editors@cioinsight.com.

Rates of Change

Rates of Change

To illustrate how scenario planning can be applied to IT issues, veteran technologist Steve Andriole and scenario planning expert Paul Schoemaker sketched out some quick scenarios. Schoemaker is research director of the the Wharton School's Emerging Technology Program. Andriole is the former CTO at CIGNA Corp., and the founder and CTO of Bryn Mawr, Pa.-based TechVestCo.

Approach: We put ourselves in the position of a CIO of a large, established firm—involved in anything from insurance to healthcare to server manufacturing—where technology is critical to the business. Then we asked, "How can we get a handle on future investments based on the environment in which we expect to compete in the next two to four years?"

Key Trends: We asked, "What are some of the long-term trends affecting the company and its consumers?"

Pervasive computing. This involves everybody having devices connected to the Net and to each other. The main uncertainty is how fast this will develop.

Privacy concerns. Pervasive computing raises concerns about who gets access to data about consumers, and that will increase the pressure for regulation.

Greater importance of security. To match the growing computing pervasiveness and privacy worries, IT professionals will need to invest in and worry more about the integrity of financial transactions, medical data and other security issues.

Such trends specific to an industry or company should be present in any scenario. What sets the scenarios apart is the way in which these trends play out.

Key Uncertainties: Next we took a look at the key uncertainties that could effectively alter the rate of change or the direction of the key trends.

Consumer acceptance of the technology invasion. To what degree will people embrace new technologies at home, work and play, and give over their lives to it?

Adoption of common technology standards. Will XML, Wi-Fi and similar technologies become the common standard? Will the world move toward open or proprietary platforms?

New killer applications. What's next after ERP and CRM? A new generation of business tools could facilitate more seamless and responsive technologies that help companies better serve consumers and clients.

Health of global economy. This is one example of the macro uncertainties that should be considered in a scenario process.

Create Scenarios: The most common technique for building scenarios is to compare the most important trend with the most important uncertainty. But when we stepped away from this problem a bit, we decided to consider the uncertainties as a cluster. The first three are fundamentally about adoption of technology by consumers and businesses. That seemed a reasonable basis against which to analyze the trends. Once the scenarios are roughed out, we can layer in macro factors, such as the last, and ask: "What is the economy likely to look like in each scenario?"

Three Futures for the Business of Technology(see figure)

New Business Model
Consumer behavior is changing rapidly and so is technology,opening up new opportunities for business. This is what the world might have looked like if wireless has taken the world by storm with a common standard across all platforms.

Seamless Communication
Consumers eagerly snap up new devices and communication technology in part because of better integration between devices. Expect continued technological advances, but these will be evolutionary, not revolutionary.

More of the Same
You could also call this scenario "gradual change." Consumer acceptance and technology evolve at their current pace. Would the economy boom in an environment like this? Probably not.

A Guide to Scenario

Planning">

A Guide to Scenario Planning

1. Choose the Issue

Define the problem or issue you want to consider. Isolate the scale. Is it local, national or international? Is it specific to an industry? Or does it encompass a number of broad technological shifts such as the rise of pervasive computing?

Choosing the correct time frame depends in part on the nature of the product or system's implementation cycle. The oil industry uses 15-year planning cycles because building a new refinery is an eight-year process. For technology infrastructure projects, looking out just three to five years might be more appropriate.

Dr. Paul Schoemaker, research director of the Wharton School's Emerging Technology Program and CEO of Decision Strategies International Inc., notes that most of his clients work in the four- to eight-year range. "If it's less than two years, it's probably not really strategic, it's more tactical," he said.

2. Gather Information

Collect new information that can help inform your discussion. Mine data from your organization about your markets and trends. Conduct some industry or competitive research. Sometimes consultants can be useful for pulling in new data, trends and analysis. Plan to spend a few weeks on this phase, not a year. Says Adam Kahane, managing partner of Beverly, Mass.-based Generon Consulting: "The main way people do a lousy job at creating scenarios is if they don't take the time to get some new information about what is going on in the world."

3. Convene the Right Group

Pull in people with diverse expertise and varying perspectives from different parts of your organization. Choose a range of ages, too. "The last thing you want is the same people talking to each other on the same issues in the same way," says Schoemaker. CIOs and consultants agree that participation and buy-in from top management is essential.

For the scenario portion of the exercise, consider inviting regulators, academics, experts and other outsiders. Columbia Business School strategy professor Kathryn Harrigan recommends that you include your suppliers, major customers and strategic partners. "If you are going to have a supply-chain relationship, your fate is in their hands."

4. Identify the Primary Forces

Find the economic, political, social and technological forces that may influence the market or technology you are addressing. Map out the major drivers in your business. Outline the major uncertainties that affect your business and the world you operate in. Michel Godet, a French scenario planning expert and author of the recently published Creating Futures, uses a technique he calls "hunting down clichés." Start with the conventional wisdom, then shoot holes in it, he advises.

Differentiate the forces over which you have no control—such as tax policy, interest rates and major political events—from those over which you have some control. Are some of the forces predictable, such as the aging of the baby-boom generation? These can be considered long-term trends. Group all relevant forces, then go over your list to determine the truly important drivers. Assign ranking by the importance and degree of uncertainty. Also, look at the key actors and stakeholders, their motivations and interactions.

5. Craft Scenarios

Create a series of scenarios that cover the range of possibilities. Don't try to establish every possible case, but look for scenarios that produce very different but plausible and internally consistent views of the world. There is no right number of scenarios.

In Godet's view, the shape of the problem should determine the number of scenarios, while Deloitte's Thomas says he encourages his clients to build four or five.

Regardless of your approach, focus on analysis and thinking, not on the technique. Techniques are simply ways to assist thinking.

6. Build Out the Scenarios

Each scenario should be a different world inhabited and explored by a small working group. Some planners write their scenarios as if they were future histories, where teams describe how they got to this future from the present. Try to create internally consistent pictures of how things would work, based on how the key drivers affect your business.

7. Align With Strategy

Art Kleiner, a scenario planner and instructor at New York University's Interactive Telecommunications Program, calls this phase "strategy, rehearsal and conversation." Among the key questions he poses: "If this world comes to pass, what would we have wanted to be thinking about ahead of time?" What do these worlds "suggest about our current strategies—are we setting ourselves up for a rude awaking?" Kleiner also recommends asking, "What kind of world do I want to create?"

Are there overarching strategies or solutions that serve you well no matter how the future develops? Can you build enough flexibility into your IT infrastructure, applications or business models so you can respond appropriately no matter which scenario unfolds? Some planners use this phase to isolate the key signposts and indicators that could help determine whether one of your scenarios is coming true.

Many consulting firms take a quantitative look at the scenarios. Analysis tools range from Excel to linear programming, from decision- tree analysis to Monte Carlo simulations that use random number generators to produce probabilities for certain events. Sebastian Ceria, a decision models professor at Columbia Business School and president of decision support firm Axioma Inc., says that a variety of powerful off-the-shelf simulations tools can model problems and generate optimum solutions in the face of large uncertainties. Usually the province of CFOs and operations managers, these simulation tools can be readily customized to handle IT or scenario problems, he notes.

Other consultants, such as Deloitte Consulting's Charles Thomas, are wary of the quantitative phase. "For the most part, executives believe numbers rather than remembering that this is just a planning tool. So they begin to think the numbers are really potential forecasts," he says. "While we can do it, it saps the creative thinking."

8. Create Action Plans

Translate your strategies into budgets, action plans and investments. Sometimes this means killing pet projects. Roy Lowrance, vice president of information technology for The Boston Consulting Group, Inc., says companies can use scenarios to gain control over their fate. For some leading-edge issues, "you can help create the future, instead of simply being reactive to the future. And those are the ones where there is the absolute highest value from IT investments, because they create a whole new set of possibilities."

9. Communicate Results

Once you've gone through the whole planning exercise, figure out how you are going to communicate the results—and to whom. Schoemaker points out that some companies disseminate the information as widely as possible, by drawing maps, writing booklets, giving presentations and pushing the results throughout the whole organization.

Others circulate the results more selectively. Andriole says he always sent the results up to top management. Even though he paid for scenario planning for each of the main business lines, he let the president of each unit decide who else in the organization should get the scenario information.

10. Monitor Events

Scenario planning is a dynamic process in a dynamic environment. The world may not fit neatly into any single one of the scenarios you constructed for it. Monitor events and look for warning signs that one or another of your scenarios are coming true. Be prepared to adjust your course.

Bain & Co.'s Darrell Rigby found that the best way to use scenario planning is to make sure it is built into the company's regular, ongoing strategic planning process. But you don't necessarily have to build a whole new set of scenarios each year. "Once you think you've gotten down to the fundamental uncertainties in this market or in this context, you don't need to redo it tomorrow, or even next week. You need to try to deepen your understanding within the uncertainty."

Glossary

Glossary

Drivers: The primary trends that will affect the world in which your company does business.

Uncertainties: The primary issues that will affect the rate of change or acceptance of your business trends.

Watchpoints: Events or directions that may signal the coming to pass of a particular scenario.

Weak Signals: Small-scale trends that could wreck your planning assumptions if they grow into big ones.

Wildcards: Utterly unpredictable events or trends that will totally null and void your scenario.

Resources

Resources

Books

The Age of Heretics.
Art Kleiner. New York: Doubleday, 1996.

The Art of the Long View.
Peter Schwartz. New York: Doubleday, 1996.

Scenario Planning: Managing for the Future.
Gill Ringland. John Wiley & Sons Inc., 1998.

On Thermonulcear War.
Herman Kahn. Greenwood Publishing Group, Inc., 1978.

Web Sites

www.gbn.com
This is the Web site of the Global Business Network, a member-sponsored consultancy and research organization focused on scenario planning.

www.idongroup.com
The Web site of a British consulting firm, it includes software that generates scenarios.