Scenario Analysis Essay

Scenario analysis attempts to capture the nonlinearity, complexity, and unpredictability of turbulent environments by incorporating techniques for eliciting and aggregating group judgments, specifically through Delphi techniques and cross-impact matrices. The Delphi technique involves asking an anonymous panel of experts to estimate individually the probability that certain events will occur in the future. The panel members have several opportunities to revise their initial estimates. They look at the anonymous responses from other experts on the panel to gauge how much their individual estimates deviate from other estimates. While Delphi forecasting can be described as constrained guesswork, its probability estimates are statistically sound because panelists selected are experts in their respective fields. Cross-impact analysis (CIA) is a complex technique sometimes performed by hand, as in the procedure pioneered by General Electric (GE), and increasingly by computer. Its output is a matrix showing the favorable or unfavorable interaction of likely developments generated earlier by the Delphi panel.

The origin of scenario analysis is claimed by theorists from many countries. Nicholas C. Georgantzas and William Acar attest that scenarios were introduced to planning literature by Herman Kahn who worked on military scenarios for the U.S. government in the 1950s. In the 1960s H. Ozbekhan of the Wharton School (of the University of Pennsylvania) used scenarios in an urban planning project for Paris, France. Pierre Wack asserts that it was a group of strategic planners at Royal Dutch Shell who came up with the idea of using scenario analysis for strategic planning in the 1970s.

Ansoff and other strategy theorists state that the 1970s witnessed the transformation of product markets into a global perspective. Changes in the external sociopolitical environment became pivotal in strategy making. Environmental challenges, many of them novel, also became progressively numerous. Combined with the geographical expansion of markets, they increased the complexity of managerial work. They rendered the managerial capability developed during the 1960s inadequate. Today, environmental challenges are developing progressively faster. Their novelty, complexity, and speed have increased the likelihood of strategic surprises.

Often regarded as the father of scenario analysis, Herman Kahn’s method underlies the type of “systems analysis” represented in On Thermonuclear War, although it became more explicit as a methodology in Kahn’s later futurological research, embodied in his book with Anthony Wiener published in 1967, The Year 2000.

For Kahn, scenarios were hypothetical sequences of events constructed for the purpose of focusing attention on causal processes and decision-points. They are designed to answer two kinds of questions: (1) How might some hypothetical situation come about, step by step? and (2) What alternatives exist, for each actor, at each step, for preventing, diverting, or facilitating the process? Kahn used scenarios to understand the alternative worlds represented by the year 2000. His method involved the sequence of steps described below.

The analyst first identifies what he/she takes to be the set of basic long-term trends. These trends are then extrapolated into the future, taking account of any theoretical or empirical knowledge that might impinge on such extrapolations. The result is called the surprise-free scenario. The surprise-free scenario becomes the base from which variations on the scenario or alternative futures are derived by varying key parameters in the surprise-free scenario. Kahn made no claim that scenarios were predictive. Instead, he was adamant that no one scenario is more probable than the other. The Kahnian approach was taken in 2002 by the Hudson Institute to investigate the possible impact on business of consumer fears post-9/11.

The value of scenarios for planners comes from a feeling of greater preparedness and flexibility in the face of high-velocity environments, as well as the “a ha!” moments created by combining key parameters from the surprise-free scenario that might be counterintuitive. Three examples provided below are drawn from the classic experience of Royal Dutch Shell and GE in writing scenarios for strategic planning purposes, and the scenarios generated by Peter Drucker to understand the impact of balance of payments deficits on national and world economies.

Examples

The team of Pierre Wack, Ted Newland, and Napier Collyns became critical to the success of scenario driven planning at the Royal Dutch Shell group of companies. During the 1972 energy crisis, only Shell was ready for the change among oil firms. The firm’s executives and managers responded together and responded fast, changing Shell’s strategic posture as well as the company’s market results. Formerly one of the weaker of the seven oil majors, Shell had become second only to Exxon in size and first in profits. Shell’s senior planners were no longer concerned about forecasting, but now focused on liberating management insight and inspiring a long-term view through scenario-driven planning. Scenario-driven planning enables managers to reperceive a strategic issue and to discern their assumptions about the issue so that they can improve decision quality. Shell’s scenario experience produced both promising results and methodological innovations. Betty Flowers, editor of global scenarios for Shell, describes a recent scenario development round for Shell called Geographies of Connection, a frame of reference through which managers explore a scenario from one of four positions: how people are connected globally; how nations are connected; how the globally connected edges of nations are connected to their own heartlands; and how we are connected to the earth through our environmental policies and practices.

Beginning in the 1960s, GE drew together into a single framework a variety of forecasting tools including Delphi expert panel to detect critical variables and indicators, as well as trend-impact and cross-impact analyses to assess the implications of the interactions among variables and indicators. The output of these techniques was used to develop probable future scenarios. GE’s procedure entails an initial determination of the key trends by the planning analysts, followed by constrained expert guesswork by one or several panels of outside experts. Cross-impact analysis follows. Its output is a matrix showing the favorable or unfavorable interaction of likely developments generated earlier by the Delphi panel.

While the Kahnian, Shell, and GE scenarios were strategic in intent, the last example here, the Drucker scenarios, represents a macro-level environmental scenario exercise. Although Drucker introduced his scenarios in the 1980s, the environmental scenarios have increasingly become an input to the computation of strategic scenarios and represent one of the few ways strategic managers can account for the overriding, pervasive issues of business and the economy.

In addressing a world economy composed of the “real” economy of goods and services and the “symbolic” economy of money, Drucker considered a total of five environmental scenarios based on the outcome of continuing overall budget and trade deficits and the impact of deficits on investor (including foreign investor) confidence.

Bibliography:

  1. Christopher L. Culp, The Risk Management Process: Business Strategy and Tactics (Wiley, 2001);
  2. Betty Flowers, “The Art and Strategy of Scenario Writing,” Strategy & Leadership (v.31/2, 2003);
  3. Nicholas C. Georgantzas and William Acar, Scenario-Driven Planning: Learning to Manage Strategic Uncertainty (Quorum Books, 1995);
  4. Barry B. Hughes, International Futures: Choices in the Face of Uncertainty (Westview, 1999);
  5. Amit Kapur, “The Future of the Red Metal-Scenario Analysis,” Futures (v.37/10, 2005);
  6. Robinson, “Future Subjunctive: Backcasting as Social Learning,” Futures (v.35/8, 2003);
  7. Ronnie Söderman, Maximum Loss Calculation Using Scenario Analysis, Heavy Tails and Implied Volatility Patterns (Swedish School of Economics and Business Administration, 2000);
  8. Philip W. F. Van Notten, Jan Rotmans, Marjolein B. A. Van-Asselt, and Dales S. Rothman, “An Updated Scenario Typology,” Futures (v.35/5, 2003);
  9. Robert R. Werner, Designing Strategy: Scenario Analysis and the Art of Making Business Strategy (Praeger, 2004).

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