Central bank rate decisions, inflation and affordability, political instability, ceasefire agreements, the onset of the next recession…
You can bet on just about anything these days by clicking a few links on a prediction market. But betting on “known unknowns” and hoping for the best on “unknown unknowns” are not viable pathways to prepare for the future, which explains why forward-looking CFOs drive scenario planning that helps set corporate strategy and build capabilities to navigate multiple potential futures.
Organizations with mature scenario-planning capabilities possess a clear sense of what that capability is and isn’t. Scenario planning is not a one-off exercise nor an appendage to managing the business. Nor is it merely a periodic forecast update. Rather, this process provides value-added inputs to improve strategy-setting, business planning and risk management. It involves developing a range of possible event-driven scenarios, assessing the impact their outcomes may have on key business drivers, and laying out which strategic and tactical decisions require consideration in response.
Asking the right questions is a critical component of scenario planning. Thoughtful, targeted questions focus senior leaders on potential futures that matter most to the organization. It is equally essential to perform thorough analyses to identify plausible as well as extreme future scenarios; a combination of cross-functional collaboration, artificial intelligence (AI) tools and savvy data collection helps on that count. The CFO sits at the center of this process because the FP&A team continually models the road ahead—and because finance can translate the organization’s most consequential risks and opportunities into financial terms that can serve as the basis for meaningful action plans should certain scenarios develop and become reality.
Less gambling, more agility
Scenario planning represents a key component of the early-warning capabilities leading CFOs implement to stress test implicit assumptions underpinning the financial plan, monitor leading indicators, and escalate when those signals flash yellow or red. Scenario planning functions as a drill or dress rehearsal for future disruptions—preparation that enables the organization’s leaders to activate next best actions that help minimize risk and maximize opportunities as disruptions begin to materialize.
As finance leaders assess opportunities to elevate scenario planning to a differentiating skill, they should consider the following:
- The CFO drives a capability that should be continuous rather than episodic: The finance group can put financial KPIs against financial and operational scenarios that these exercises generate, as well as the responses that different scenarios warrant. Regional conflicts, shipping choke points and other supply chain disruptions, new competitors, health breakthroughs, AI inflection points and other economic, technological, regulatory, geopolitical and social disruptions do not operate on an annual cycle; nor should scenario planning.
- Anchoring scenarios to material business drivers reduces analysis paralysis: Some planning exercises buckle due to what I call “TMS”—too many scenarios. Rather than working through every possible scenario, conduct an environmental scan that identifies events that could materially impact performance. Some organizations start by running through low/medium/high business-driver impacts and then layer on disruptions. Analyzing plausible trends (if the price of oil hits X, we do Y and Z) is often more productive than focusing on an unpredictable one-off extreme event like a massive oil spill or a natural disaster.
- Cross-functional collaboration is mandatory: Scenario planning is more robust when it incorporates perspectives from a variety of stakeholders whose insights help broaden analyses and challenge biases. Operational leaders possess comprehensive knowledge of supply chain disruptions. Tax experts bring unique takes on tariffs and other geoeconomic risks and alternative paths for response. Deal teams understand M&A and capital markets dynamics. Product development teams have visibility into lengthy pipelines.
- High-quality, comprehensive data is the foundation: Next-generation scenario planning leverages AI tools to query data lakes containing a comprehensive mix of internal company data and external data (relevant economic and competitive indicators, commodity prices, geopolitical risks, global trade risks, consumer signals, demographic shifts and more). AI tools, including those available in existing enterprise performance management (EPM) and other planning systems, identify patterns and use the data to run simulations.
A break-glass-in-case playbook
Leading scenario planning capabilities operate according to a leverageable playbook containing predefined “break-glass-in-case” actions the organization can execute as a scenario unfolds in real time. Building this playbook facilitates organizational agility and requires cross-functional teams to progress through the following areas and questions:
Clarifying purpose and objectives:
- Are we developing scenarios to support strategic planning, risk management or innovation?
- What specific challenges, uncertainties or opportunities are we trying to address?
- What time horizon should we use?
Identifying key drivers:
- What are the most significant external forces influencing the scenario (e.g., economic, technological, regulatory, environmental or social)?
- Which internal factors (e.g., organizational capabilities, culture, resources) could impact potential outcomes?
Exploring uncertainty and potential risks:
- What are the most unpredictable variables that could significantly impact outcomes?
- What cascading effects might occur if one variable were to change significantly?
- What are the worst-case, best-case and most-likely scenarios—and what triggers each?
- Have we factored in geopolitical considerations (e.g., what if China makes a play on Taiwan or the Strait of Hormuz were to remain shut down for an indeterminable period)?
- What risks could arise from blind spots or unanticipated changes in the environment?
- How would different stakeholders (e.g., customers, employees and regulators) respond to each scenario?
Identifying decisions and actions:
- What response strategies or actions are most effective under each scenario?
- How can we build flexibility and resilience to adapt to multiple potential futures? What early warning indicators should we monitor to identify which scenario is unfolding?
Stress-testing assumptions, challenging biases, and adapting:
- What assumptions are we making and how might they change?
- Are we challenging our own assumptions and considering alternative viewpoints?
- What biases might be influencing our thinking, and how can we mitigate them?
- How do our current capabilities hold up under stress testing the scenarios we have selected? Do they hold up under extreme conditions?
- How can we use knowledge gained from developing and analyzing these scenarios to refine our strategies, decision-making processes and other capabilities, and to plan for contingencies?
- How will we update these scenarios as new information becomes available?
Planning for unknown unknowns
While the above questions are illustrative, they are comprehensive enough to enable one to understand the rigor of the scenario planning process. The point is this: After addressing these questions, leadership teams can engage in periodic role-playing scenarios that test their ability to make high-stakes decisions in real time. And this is the world in which we operate.
Tabletop exercises that pit adversarial teams against each other to challenge key assumptions also facilitate asking the right questions. I am reminded of the scene in the 2019 movie Midway in which the Japanese admiral, Chūichi Nagumo, was upset that a member of his staff, Minoru Genda, kept violating the rules of engagement during their pre-invasion war planning exercise. Genda kept placing the American carriers in a position that enabled them to destroy the Japanese fleet. Nagumo insisted that the American carriers weren’t supposed to be there! All Genda did was ask, “What if they are there?” And, of course, the rest is history.
We may be unable to predict “unknown unknowns” events, but by developing and testing scenarios linked to material business drivers and strategic assumptions, we can understand how much such events might hurt or help. When insightful scenario planning drives actionable response plans, leaders can better prepare the organization to pivot in the face of a range of possible futures, including those consisting of “unknown unknowns.”
