Part 7 in the 10-part Collaborative Enterprise Planning series
It has been said that the budget is the one scenario guaranteed not to work. The business world is far too complex to have a definitive view of what’s going to happen 12 months down the road. In this environment, scenarios can play an important role, but only if they are part of an overall collaborative approach.
With a collaborative approach, scenarios become in effect a short story about what might happen. They present a snapshot of a future business environment encompassing the market, competitors, and potential customers. The scenario is the basis for a model that places the organization into this environment with respect to the product and services it could offer, the price target, and volumes likely to be sold. These models are best set up as driver-based, where entering a few values in the planning system generates high-level numbers such as total income, expenditure, and profit levels.
From this, what-if scenarios can be generated by looking at the changes required for the organization to improve the projected figures and how those changes would be funded.
In his book Best Practices in Planning and Performance Management, David Axson commented:
“Planning is not about developing a singular view of the future: one of the most valuable elements of any planning activity is the ability to factor in the impact of risk on assumptions, initiatives, and targeted results. A scenario is a story that describes a possible future. It identifies significant events, the main actors, and their motivations, and it conveys how the world functions.”
In developing different scenarios, it’s important to model the organization as it is today and get general agreement on that model. This can be done by taking the key high-level numbers (costs, income) and defining their natural causation. For example, sales revenue may be the cumulative result of marketing, lead generation, sales calls, customer references, and contracts signed. Similarly, production costs may encompass raw materials, fabricating them into products, and packing and shipping them to customers.
These linkages can be modeled so that entering information such as workloads or targets can generate a prediction of the resources required. This is known as “driver-based planning.”
Drivers are found by taking a target measure (revenue or some other outcome) and determining the factors that directly impact its value. For those factors, you then establish what impacts them and so on. Measures at the end of the chain are known as drivers. Entering data into a driver value allows the model to calculate the target measure.
Sophisticated driver models recognize constraints such as production volume and that, at certain levels, cost and revenue profiles may change. For example, the impact of discounts, late-delivery penalties, or the need for more staff will cause a step change in values. The models also recognize that there is nearly always a time lag between the driver and the result it supports.
Once you have a basic model, it’s important to validate it against past data and to communicate the results to managers. Keep in mind that the model will never predict the results with 100% accuracy, as there are far too many influencing factors, but the numbers should be within an approximate range.
This model is then circulated to the next level of management as relevant, and its function explained. Encourage managers to provide feedback, but be sure to explain that it is intended to be used as a model of the whole company working together.
Generating additional scenarios
Once you have buy-in, the model can be used to generate additional scenarios based on both a range of driver values and potential operational changes.
These can then be compared side-by-side, showing outcomes, assumptions, and details of proposed changes. From this, management can put forward the preferable scenario, which should reflect the strongest likelihood of implementation, the best potential short- and long-term outcome, the most affordable cost, and the lowest risk. This becomes the target of operational budgets.
If there are those in your organization convinced that they don’t have the time to do this, leading proponents would contend that you can’t afford not to. With this approach, management already has potential plans to put into action as the business environment changes, rather than panic and let events take over.