What does the future world look like? How will our value change over time? What's the risk to our organization? If you're a finance leader, these are a small sample of the questions that you wrestle with. Many finance professionals would say that they confront these questions through budgeting, planning, and forecasting.
Yet, Rich Clayton, vice president of product strategy at Oracle, argues that these processes aren't enough to inform a company about what may happen in the future. Scenario modeling, on the other hand, helps companies map out multiple views of the future, over different time periods, with different assumptions. Clayton explained the difference between these two processes and gave some helpful tips about how to get started with scenario modeling in a recent webcast with FEI (Financial Executives International), called Scenarios Made Simple, which you can review on demand.
Budgeting, planning, and forecasting are processes designed to articulate how a particular strategy will unfold in the future and communicate key assumptions to business leaders throughout the organization, Clayton explained. It's the plan of record against which the company makes decisions. The problem with these processes is they look into the future based on a single set of assumptions. It's not that these processes don't serve a purpose. It's that they're not enough.
Scenarios, on the other hand, Clayton said, map out multiple views of the future, over different time periods, with different assumptions. But more than that, the process of building different scenarios is a tool for confronting the flaws in how an organization thinks about the future and encourages discussion and debate on any number of situations—from large, black-swan events to volatility in the market to major disruptions and changes in the competition.
Scenarios Done Well
If you want to see an example of scenario modeling done well, Clayton points to Royal Dutch Shell, the global oil and gas company that has been doing scenario modeling since the early 1970s. Back then it was facing a changing regulatory environment and needed to imagine a future where they could successfully navigate those changes. Today, Shell's scenario-development practice is an institutional competency that they've used to investigate everything from improving the response to AIDS in Africa to how natural gas could become a mainstream energy source in China.
As you can imagine, Clayton noted, these aren't easy problems to confront. But then again, filling the gap between what's happening now and what will have happened in the future is never an easy task—not for emerging energy markets and certainly not for your business. That kind of thinking requires decoupling the past from the future, which seems deceptively straightforward. But as Shell's resources on scenario modeling point out, the same area of the brain is responsible for both picturing the future and remembering the past. Conflating the past with the future is part of our biology.
"That's where the scenario modeling development process becomes useful," Clayton said.
The Journey Is the Reward
During his presentation, Clayton pointed to this quote from well-known strategic management, decision-making, and leadership expert Paul J.H. Schoemaker:
"Scenario planning is as much art as science, and prone to a variety of traps (both in process and content)."
Clayton explained that these traps can be everything from looking at the wrong drivers to making a scenario so detailed (read complicated) that decision makers don't know what to glean from the findings.
That why, Clayton advised, it's important not just to do scenario modeling, but to go through the process for doing agile scenario modeling. An agile process is something that's fast to produce and adjust, takes into account all the dimensions of financial integrity (whether that's cost to capital or foreign exchange rates), uses carefully selected drivers, goes through a clear feedback loop, and makes use of visuals so the findings are easy to grasp.
Ultimately, scenario modeling can be difficult, but the process can change your company from an organization that's often surprised by the future to one that's prepared for it. And, as Clayton covers in detail in his webcast, it can also be made easier with the right competencies and tools.
Register to review the on-demand version of Clayton's FEI webcast Scenarios Made Simple to go into much more detail about how to create an effective scenario-modeling competency within your company.
And click here to see more on how Oracle can help your company outperform your competitors by providing a strategic modeling platform called Essbase Cloud Service for all your scenario analysis and performance measurement needs.