Traditional Forecasting vs. Scenario Planning

Writing this week’s post, I was engrossed in the academic and professional literature comparing traditional forecasting and scenario planning.  Professionally, I serve as both the Chief Financial Officer and Chief Strategy Officer for a portfolio company held by a private-equity firm.  Most of my days involve discussing the current and expected business performance via forecasts generated by our various operating companies nationwide.  These forecasts are then communicated to our executive team, investors, and banking partners.  A common phrase we use within the finance community that is well written within the academic literature, too, is, “As soon as a forecast is published, it’s wrong” (Amer et al., 2013; Coates, 2000; Peterson et al., 2003).  If accurate, how can strategists and futurists provide a better framework and greater context to these forecasts?

Traditional Forecasting

Traditional forecasting is the most likely scenario and then estimating, or quantifying, the expected results (Amer et al., 2013; Coates, 2000; Peterson et al., 2003).  The advantage of traditional forecasting is that it outlines all possible variables and the pathway to the end result (Amer et al., 2013).  A forecast provides the users a mechanism to validate their estimates retrospectively and often quantify the impact(s) of a positive or negative miss in the case of a private-equity company (Amer et al., 2013).  It provides the best possible scenario and is founded on the premise that the forecast ensures optimal decision-making (Peterson et al., 2003).  The primary disadvantage of traditional forecasting, especially in the world of private equity, is that a model with twenty (20) variables, all with a ninety percent (90%) accuracy, will only have a twelve percent total accuracy (12%) (Coates, 2000).

Scenario Planning

In contrast, scenario planning is a structured approach for identifying and creatively thinking about multiple complex variables and creating multiple possible futures (Amer et al., 2013; Peterson et al., 2003).  Scenario planning outlines a possible future, like a writer developing an outline of a novel from which the writer develops the story (Coates, 2000).  Two famous examples of scenario planning include the military war games developed by the RAND Corporation and the Royal Dutch Shell company’s business scenario planning in the 1970s (Coates, 2000; Peterson et al., 2003).

Like traditional forecasting, many qualitative and quantitative approaches can be used for scenario planning.  The advantage of scenario planning is the creative identification of multiple possible futures from which users can adapt their plans or futurists to consider (Amer et al., 2013).  The disadvantage in the business environment is that an investor or a bank requires a forecast or commitment to a specified outcome. 

Conclusion

As a scholar-practitioner, I view the tremendous benefits of both traditional forecasting and scenario planning.  Like a peanut butter and jelly sandwich, neither is truly great without the other.  Scenario planning allows for the creative identification of potential futures.  Traditional forecasting allows identification and commitment to the best or most likely scenarios to be taken “to the bank.”

If you would like to learn more or to provide comments, please see my references below or leave a note in the comments section!

References

Amer, M., Daim, T. U., & Jetter, A. (2013). A review of scenario planning. Futures, 46, 23-40.

 

Coates, J. F. (2000). Scenario planning. Technological forecasting and social change, 65(1), 115-123.

 

Peterson, G. D., Cumming, G. S., & Carpenter, S. R. (2003). Scenario planning: a tool for conservation in an uncertain world. Conservation biology, 17(2), 358-366.