7 Steps to Scenario-Based EPM

BusinessFinance published an Axiom EPM sponsored paper on scenario modelling and driver based planning. The paper is great read and I highly recommend it. Below are my picks from the publication:

Extraordinary is now the ordinary. Today’s global business operating environment is characterized by ongoing uncertainty and volatility. Businesses are operating under extraordinary circumstances and what we previously regarded as unthinkable is now a reality.

Much of the uncertainty and volatility confronting organizations is result of shift in economic powers, an increased demand for commodities, rapid demographic changes, increased environmental concerns, global interdependence and technological innovation.

Because of these new and unforeseen challenges, companies need to transform their planning, budgeting and forecasting. The past is no longer a good predictor of the future.

Instead of basing strategies, plans and targets on a single static view of the future, derived from an extrapolation of past performance, companies should consider moving to scenario based enterprise performance management (EPM). This helps management to regularly consider different scenarios when running the business on an ongoing process.

In an environment of growing uncertainty and volatility, it is no secret that traditional forms of analytical planning are inadequate. What is required from managers is open-minded thought and imagination that spirals around possibilities and scenarios.

Therefore, forecasts and budgets made on fixed assumptions are inappropriate. In fact, understanding and monitoring a company’s value drivers requires a rolling, nearly real-time approach to planning and forecasting, as opposed to an annual exercise.

Scenario-based EPM  can assist, not just in strategic planning, but also in business planning, forecasting, reporting and analysis, providing the foundation for risk mitigation strategies, integration of early warning measures into performance management and, perhaps most valuable of all, for managing the unexpected nature of day to day business.

Incorporating scenario planning into strategic planning, budgeting and forecasting processes enables the organization to become more proactive as opposed to being reactive.

Scenario planning helps managers to ask the right questions, anticipate changes in the environment, identify scenario triggers and make course corrections more rapidly and efficiently.

Ultimately, this also helps the company to avoid paths that lead into negative territories if the company is currently in positive territory; and if it is currently in negative territory, to choose paths that will lead it put and avoid paths that will cause further value destruction.

Incorporating a scenario capability into an organization’s EPM processes requires seven steps:

  • Identify the key factors that can have a material impact on the organization. For example, consumer products companies may look at GDP growth and consumer spending, airlines at oil prices, global manufacturing companies at exchange rates and freight costs, and financial services companies at consumer credit quality, interest rates and asset prices.
  • Define relevant scenarios (typically three to four) that describe a range of future operating environments. For example: What if oil prices average $75 a barrel, $110 a barrel or $200 a barrel?
  • Agree on a baseline scenario that will be used to develop/review strategy, set targets and develop operational plans and budgets.
  • Develop strategic plans, targets, action plans and budgets using the baseline scenario.
  • Develop alternative views of targets, plans and budgets under each scenario. Identify the major impacts and changes under each scenario. For example:
    • What will be the positive or negative impact on key financial metrics such as sales, margins and earnings under each scenario?
    • How will investments and projects be reprioritized under each scenario?
    • What will the impact be on product mix, pricing and promotional spending under each scenario?
  • Identify relevant triggers and corresponding tolerance ranges for each scenario that should be monitored on an ongoing basis in order to provide management with advance warning of material changes in the operating environment.
  • Whenever established triggers or tolerances are exceeded, meaning a new scenario becomes effective, adjust tactics using the previously developed plans and generate a new forecast reflecting the change in the scenario and the changes in tactics.

Thus if the company is to achieve any form of control over its future and outperform its competitors, then the identification of the pivotal uncertainties shaping future scenarios is critical. In addition to avoiding and mitigating risk, scenario-based EPM can also be used to identify and seize growth opportunities in developed and emerging markets.

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