In the wake of Brexit, it seems as if the only certainty is uncertainty. Nothing like this has happened before, and the UK will be the first member to exit the EU in its 59 year history. Within hours of the decision being made, the pound fell to its lowest point since 1985, the FTSE fell by seven percent minutes after opening, and other markets around the world took a dive. Financial services took a particularly heavy hit. Financial markets simply don’t like uncertainty and unfortunately this is exactly what we will get for some time to come.
What is clear is that businesses of all sizes and in every discipline in the UK will be affected by this decision, and many global businesses, large and small, will feel the implications as well.
Instead of sticking their heads in the sand, companies can put systems in place that allow them to explore the various possible future states and even put early warning indicators in place to show that things are changing.
Scenario analysis, also known as horizon analysis or total return analysis, is an analytic tool that allows you to look at a variety of possible future events or ‘scenarios’ by considering alternative possible outcomes.
Often it’s only when you really consider what would be involved in the actual implementation of an idea do you fully appreciate the scope of that idea. Scenario analysis allows you to improve decision-making by fully considering the outcomes you expect and their implications without the cost and time involved in actual real world implementation.
Scenario analysis does not rely on historical data and doesn’t expect the future to be the same as the past or seek to extrapolate the past into the future; rather, it tries to consider possible future developments and turning points.
It is also a very useful tool in times of uncertainty. This amplified engagement can help to anticipate more of the pros and cons of each scenario, therefore reducing risk and directing you to the best choice.
How to use scenario analysis
Scenario analysis can help the decision-making process by looking at the likely implications of that decision and how it might or could pan out in the future. In the case of Brexit uncertainties, it can help you to answer:
- which strategic direction do we take?
- what are the best countries to expand our business into?
- how will my business be affected if the pound continues to fall?
- what would be the impact of new trade relations and regulations?
Essentially what you are doing in scenario analysis is attempting to work out if the world would turn out a certain way when certain conditions were met. The process usually consists of a five-stage process.
1. Define the problem: work out what you are trying to solve or gain greater understanding in, and the time horizon of that problem, so you can make the best decision
2. Gather the data: Identify what data and information you need to make the analysis as realistic as possible. Businesses can understand and monitor trends using data from tools like Google Trends which are based on big data and the analysis of search trends.
3. Separate certainties from uncertainties: Take a moment to challenge all your current assumptions and decide if they are certainties or uncertainties. Always best to err on the side of caution. List the uncertainties in order of priority with the largest, most significant uncertainties at the top.
4. Develop scenarios: starting with the top uncertainty – what would you consider to be a good outcome for that uncertainty? What would be a bad outcome? Once you’ve done this develop a story of the future around each that marries the certainties with the outcome you’ve chosen.
5. Use the outcome in your planning: use the scenarios to influence and guide your planning.
In deeply uncertain times, like the ones we’re facing post-Brexit, scenario analysis can be an incredibly useful tool to manage many different possibilities in business planning. By creating a few scenarios — even the out of left field scenario — you can end up uncovering new information or insights that were previously unknown which not only assist the outcome but can also address what’s happening in the business right now.
That said, it’s easy to assume that what you think you know about the current situation is true and jump to conclusions or automatically assume that you are certain about some of the influencing factors. Scenario analysis will always yield the best results when you challenge all your assumptions in the process.