Wind-tunnelling: stress-testing a strategy against scenarios

A scenario is a plausible story about how the outside world might look in five or ten years. A set of scenarios is neither a prediction nor a forecast with a high case and a low case. Wind-tunnelling runs the strategy through three or four different futures and asks, in each, whether it survives.

The output is a shorter list of choices. The moves that are right in every future. The moves that are right only in some, and need a trigger. And the bets the business is knowingly making.

Most strategies are built on one future, usually last year plus a trend. The plan carries a sensitivity table that varies it by a few percent either way. That table measures a forecast's margin of error, and it leaves uncertainty untouched. The futures that break a strategy are the ones where the structure of the market changes. A sensitivity table cannot reach them.

Scenarios versus forecasts

A forecast extrapolates from what is known and asks how far it might be wrong. A set of scenarios starts from what is not known and asks how differently things could turn out. The forecast serves next year's budget better. The scenarios serve choices that take five years to pay back, because those choices are exposed to the futures the forecast cannot see.

Two rules keep scenarios honest. They describe the world outside the business, and leave the business itself out. And they are built from uncertainties the business does not control. A scenario built around "we succeed" or "we fail" is not a scenario.

How to build a small scenario set

The process has seven steps. A team can do it in a few workshops with a week's preparation. The quantified version takes longer, and it is worth it when a large investment hangs on the answer.

1. Fix the question and the horizon. What decision is the exercise for, and over what period? "Should we build the second plant?" over ten years is a scenario question. "What will next year's volume be?" is not.

2. List the outside forces, from the outside in. Start with the forces the business cannot influence at all: economy, demographics, technology, regulation, resources, social change. Then the industry forces it can influence a little: demand, customer needs, competitors, channels. Only then its own environment. Most teams start from the inside and never reach the forces that matter.

3. Separate the trends from the uncertainties. A trend has a knowable direction and belongs in every scenario: an ageing customer base, a technology getting cheaper. An uncertainty could tip either way and matters a lot. Examples are whether a regulation lands, whether a substitute reaches price parity, and whether the largest customer consolidates. Rank the uncertainties by impact and by how uncertain they are.

4. Pick two critical uncertainties. Choose the two with the highest impact and the least certainty. They must be independent of each other, and outside the business's control.

Two axes give four futures. Try several pairs before settling. The first pair is rarely the best.

5. Write the four scenarios. Each gets a name and a short story of how the world got there. Each describes what customers, competitors, suppliers and regulators are doing in it.

A good set is plausible: each could happen. It bears on the decision. It diverges, stretching in different directions. It is balanced, never three disasters and a dream. And it is challenging, never four versions of today.

6. Run the strategy through each. This step is the wind tunnel. For each scenario, ask how the current strategy performs and which of its assumptions fail. Ask what a business that wins in that world looks like. Then ask across the set: are we prepared for any of them, or are we betting everything on one?

7. Sort the moves and set the signposts. What survives every scenario is a no-regret move: do it. What is right in some scenarios is a conditional choice. Name the condition, give it an indicator and a trigger, and assign someone to watch it.

What is right in only one is a bet. Make it knowingly, size it to match, and say so. Those indicators become the strategy's assumptions and triggers.

Example: A building-products distributor's strategy assumes steady housing starts and stable import prices. Its two critical uncertainties are the direction of housing activity and whether a large overseas producer enters the market directly.

Take the scenario where housing falls and the producer enters. There the second warehouse is a liability, and the trade-counter network is the only thing that holds. The warehouse becomes a conditional choice with a trigger. Investment in the counters becomes a no-regret move.

What wind-tunnelling changes

Three things, usually. Some initiatives hold up in every scenario and get accelerated, because they no longer need the forecast to be right. Some turn out to depend on one future and get staged, with a trigger before the next tranche of money. And the strategy acquires a short list of things to watch. That list turns an annual document into a living one.

It also changes the conversation. A leadership team that has walked through four futures argues less about whose forecast is right. It stops trying to be right about the future and gets ready for several.

Example: An agricultural-inputs business runs the exercise around water policy and commodity prices. Its stated strategy performs well in two scenarios and badly in two. The team leaves the strategy as it is.

It halves the size of the first step and adds two indicators to the board pack. It agrees the decision it will take if either trigger fires. Eighteen months later one does, and the decision takes a week instead of a year.

Pitfalls

Uncertainties that are choices or outcomes: "whether we win the contract" is not an axis. Axes so extreme that two scenarios are implausible and get ignored. Correlated axes, which collapse four scenarios into two.

Scenarios that are variations on today with different weather. A set built by one function, which produces four versions of that function's worries. And the commonest: building the scenarios well and never running the strategy through them. The exercise then produces four stories and no decisions.

The five stages of handling uncertainty

How trends and uncertainty are handled is one of the practices in the facts-and-foresight dimension of a Stages of Excellence strategy assessment. The five stages read:

• Lagging: The plan assumes next year looks like last year; surprises arrive as crises.
• Basic: Trends get a slide in the planning pack and no consequences in the plan.
• Competent: The two or three outside forces that could reshape the business, a trend, a policy shift or a dependency, are named, with a stated position on each.
• Advanced: Key uncertainties are explored as scenarios and the strategy has been wind-tunneled against them.
• Leading: The strategy balances commitment and flexibility deliberately, taking big bets where confident, options where not.

Most businesses are at the second stage. The move to the third needs no scenarios at all, only a named position on the forces that matter. The scenarios are how the third stage becomes the fourth.

Frequently asked questions

How many scenarios? Four, from two axes, is the standard, and it is enough. Three works if one quadrant is implausible. With more than four, the team cannot hold them in mind.

How far out should the horizon be? Far enough that the structure of the market could change, and no further. Five years for most businesses. Ten where the assets are long-lived. Beyond that the stories stop being useful.

Do we need a model? Not to start. A qualitative pass in a couple of workshops finds the no-regret moves and the bets. A model earns its place when the decision is large enough to justify quantifying each scenario's profit pool.

How often should the scenarios be revisited? When a trigger fires. Otherwise once a year, briefly, to ask whether the axes are still the right ones. Someone watches the signposts monthly. The scenarios themselves are not rebuilt.

Isn't this planning for the worst? No. Half of a good set is better than today.

The exercise finds opportunities the forecast hides as often as it finds risks. A business that only stress-tests for downside has built two scenarios. A full set has four.

• Have you wind-tunnelled your strategy, or just sensitised the forecast? Take the check.
• The Stages of Excellence in strategy
• How strategy processes fail