What is scenario analysis and how can it help you make better decisions?

2 Steps of scenario analysis

Scenario analysis typically involves the following steps. First, you need to define the problem or opportunity that you want to analyze, and the scope and time horizon of your analysis. Second, you need to identify the key factors and uncertainties that affect your problem or opportunity, and how they relate to each other. Third, you need to select a few scenarios that represent different combinations of these factors and uncertainties, and that cover a range of plausible outcomes. Fourth, you need to analyze each scenario using your models and methods, and evaluate the results and implications. Fifth, you need to compare and contrast the scenarios, and identify the best decision or strategy for each scenario, as well as the commonalities and differences among them.

3 Types of scenarios

When conducting an analysis, you can use a variety of scenarios depending on your purpose and approach. A baseline scenario reflects the current or expected situation, with the most likely or average values of the factors and uncertainties serving as a reference point for comparison. An optimistic scenario reflects the best possible outcome, based on the most favorable or highest values of the factors and uncertainties, while a pessimistic scenario reflects the worst possible outcome, based on the most unfavorable or lowest values of the factors and uncertainties. An alternative scenario reflects a different or unexpected outcome, based on different assumptions or values of the factors and uncertainties. Each scenario offers insight into the potential benefits and opportunities, risks and challenges, and changes or surprises of your problem or opportunity.

4 Tools for scenario analysis

There are various tools and techniques that you can use to create and analyze scenarios, depending on your data, models, and objectives. For example, you can use a scenario matrix to combine two or more key factors or uncertainties and assign values or levels to each factor. A scenario tree allows you to branch out from a baseline scenario and add different events or conditions that affect your problem or opportunity. Additionally, a scenario simulation uses a mathematical model to simulate the behavior and interactions of the factors and uncertainties that affect your problem or opportunity. By varying the values or parameters of the model, you can generate different scenarios.

5 Examples of scenario analysis

Scenario analysis is commonly used in operations research for a variety of fields and applications, such as project management, supply chain management, risk management, and strategic planning. This type of analysis can help make better decisions by evaluating the feasibility, profitability, and risk of different alternatives. For example, in project management you can compare the net present value and payback period of different alternatives under different scenarios of inflation and interest rate. In supply chain management you can optimize the design and operation of your network under different scenarios of demand variability and supply disruption. Additionally, scenario analysis can be used to identify and assess potential risks and uncertainties that affect your problem or opportunity, as well as to formulate and evaluate strategic goals and objectives. With scenario analysis you can determine the optimal level of risk exposure, the best strategic positioning, and the most effective competitive advantage for your problem or opportunity.

6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?