Business Forecasting in Uncertain Times: The Importance of Scenario Planning

18 Months On, Revisiting Foros Perspectives on Distribution of Potential Financial Outcomes

On January 3rd, the World Bank published its 300+ page annual report with perspectives on the prospects for the global economy, predicting 2.5% global GDP growth for 2020 and 2.6% for 2021. The IMF released a similar publication on January 20th, forecasting 3.3% and 3.4% growth, respectively. These reports are extensively consumed by investors, policymakers, and business leaders to inform critical decisions with significant implications covering all pockets of the economy. In both analyses, there was no range of potential outcomes and no reference to an associated confidence interval – merely point estimates assuming a linear trajectory from 2019.

Like the World Bank and IMF, corporations typically prepare for the future with a linear psychology. Companies devote considerable time, energy and resources into budget planning, only for a single path to emerge that plots the company’s long-term strategy and outlook, often referred to as the organic base case plan.

Of course, no one predicted this global pandemic, let alone an economic crisis of this scope and magnitude. But in this current environment, we are reminded of the criticality of scenario planning. Eighteen months ago, we wrote a Foros Perspectives highlighting how public companies wrongly anticipate a steady stock price appreciation within a reasonable range. We advocated for companies to consider the broad dispersion of potential outcomes, evaluate the implications of those outcomes, and develop an action plan on the basis of that range of potential outcomes.

At Foros, we apply a differentiated, non-linear framework. And we fully acknowledge a collective inability to predict the future. We assist our clients by asking them to envision and model scenarios outside the normal distribution of outcomes. A mature software company with a predominantly on-premise offering that has historically produced a reliable, consistent earnings stream would be remiss to assume that the future will simply be an extrapolation of past performance. Further, we do not believe in simplistic upside and downside cases that vary growth rates and profitability margins by +/- 10%.

Our Strategic Assessment offering entails deep analysis that rigorously stress-tests a company’s organic base case plan. We help identify the key variables and factors that can have a disproportionate impact on the company’s prospects. And we push the boundaries by sensitizing those assumptions in radical ways to illustrate possible outcomes. In the mature software company example, it is necessary to simulate a substantial shift of workloads to public cloud environments with cannibalistic implications on core product pricing and volume. This approach generates valuable insights that provide management teams and Boards the requisite tools to make more informed, well-rounded decisions that impact the company’s future.

Crises have rocked the U.S. economy or financial system every 5 years on average over the last 30 years. Companies need to expect the unexpected, consider the outcomes and plan accordingly.