Scenario Planning in Anaplan, Part I: The Power of 'What If'
The term VUCA—an acronym for Volatility, Uncertainty, Complexity, and Ambiguity—was first leveraged in the business environment in the late 1980s, but the impact of that term in our modern world has rarely met the tests that the year 2020 brought. Organizations around the world are united in finding ways to meet the challenge of VUCA, and many have turned to scenario planning as a new tool in their FP&A arsenal. While there is a lot of information on the theory of scenario planning, I would like to present and illustrate some practical considerations and guidelines that I have found useful and effective in building scenario planning capabilities within Anaplan.
Beyond Budgeting and Forecasting
This year, changes beyond our imagination happened: barriers and business operating models that were previously resisted or inconceivable were broken, organizations disappeared and were acquired, and businesses that had never been imagined were created overnight. Very early on in 2020, most organizations realized that the usefulness of their most recently completed budgets was limited, at best. They turned, instead, to more frequent forecasts. Scenario planning does not replace budgeting (if you still do that) or forecasting. Rather, it is the first step to help establish a single plan or forecast based on the agreed set of assumptions and course of action to be taken.
Consider the “Three Whats”
Following basic principles, I often consider the role of the CFO in asking three key questions:
- What? What happened or might happen?
- So What? What is the impact of those events?
- Do What? What options do we have after and what do we do now, in advance?
It’s important to not focus only on identifying possible events and their impact as it's even more important to focus on action. FP&A’s task is to guide the organization in making effective decisions. Those decisions need to incorporate not only the changes in inputs and their impact but also an evaluation of those actions that the organization could take after they occur. More importantly, it's critical to consider what actions can we take now that might mitigate risk or position for the exploitation of opportunity. In this light, some CFOs now talk about scenario management [i] instead of scenario planning.
Key Steps for Scenario Planning
The core steps to be followed in developing and executing scenario plans [ii] include:
- Create a base forecasting model, ideally driver-based.
- Develop a wide range of potential scenarios (probable and even improbable) leveraging sets of drivers and assumptions.
- Narrow the scenarios to a shortlist, including a base scenario. Ideally, this should be done using statistical techniques.
- Develop a set of potential actions that could be taken (a “playbook”) and then selectively applying them to each scenario.
- Assess risk and identify leading indicators.
- Identify positioning actions and their cost and value that can be taken in advance, and potentially identify “no risk moves” that can be taken under all scenarios to mitigate risk or position for growth. Establish detailed operational playbooks for the actions that are most likely and/or consistently most useful.
- Incorporate scenario planning into your ongoing financial planning activities.
Translating This to Anaplan
The "Three Whats" provide a framework for developing an effective approach in Anaplan:
Develop a driver-based model.
- Where possible, start from your existing forecast model. I have found it generally helpful to build a higher-level model. For example, product details could be rolled up to a line of business level, organizational structures, and customer groups could be aggregated, and modeling could be done on a quarterly basis instead of monthly (but should extend longer—ideally two to three years).
- Consider the drivers of revenue and build inputs with overrides to allow for scenarios to be rapidly constructed. Ensure that the revenue analysis is appropriately dimensioned to handle required inputs.
Use of Driver Rates and Overrides to project Business Volumes
- One of the most impactful changes is often headcount-based. Consider those costs which vary with headcount and develop cost-per-head ratios. Then, measure productivity rates per head based on key drivers in each area (for example, new customers, orders, suppliers, etc.).
- Identify those costs that are volume sensitive versus those items that are not sensitive to changes in business volume. Note that this is different than costs that are "fixed." For example, the cost of finance headcount is “variable” in the classic accounting sense but is unlikely to vary much with business volume.
Use of Volume Sensitivity, Variability and Fixed Cost Growth Rates to Forecast Headcount and Operating Expenses
- If you have an activity-based cost (ABC) model, use it to improve your understanding of drivers and their associated costs.
- If you don’t have an ABC model (or in addition to it), look to other analytic tools such as regression analysis to confirm the relationship between and amongst drivers and revenues and costs.
- Where appropriate, include a high-level capability for forecasting critical balance sheet items (cash, receivables, investments, inventory, and debt) and ensure that you have the capability for incorporating capital expenditures.
- In Anaplan, I have found it preferable, for this use case, to treat scenarios as a numbered list, and not to use “Versions.” In this way, users can rapidly add new scenarios, copy assumptions from one scenario to another and easily compare across scenarios. In place of switchover, use a Time Settings module to indicate actual and forecast periods, and use Dynamic Cell Access (DCA) to restrict input to forecast periods. Leave input “hooks” for actions and plays to be incorporated.
- Add "scenarios" as list dimensions to your forecast modules. We will build in action controls to add the action variables to the scenarios in the second part of this blog series.
- Identify a broad range of scenarios and their inputs. (This is the “What.”) Consider only what might happen, not what you would do (actions) as a result. For example, what if revenue in a certain product line, geography, or customer segment had an order-of-magnitude change—either positive or negative? Follow D.I.S.C.O. principles by isolating inputs variables, dimensioned by scenario, from calculations and outputs. Consider generating an extensive set of inputs for each variable to construct a large set of scenarios [iii] using the power of the Hyperblock.
- Measure the outcomes of each scenario. What is the impact of that change in the short and long term? (This is the “So What.”) Identify the probability of each scenario and its impact. For example, under what scenarios could the business become insolvent? Note that it is not always appropriate (although tempting) to multiply the outcome by the probability. Consider 2020—few predicted the events but the outcomes were extraordinary by most measures.
Develop plays and actions.
- Having developed a set of scenarios and potential outcomes, the analyst can then proceed to apply different “plays” (the “Do What”), either in advance or during the scenario. For example, building redundant assets has a cost but the NPV of that investment could be positive under any scenario (in which case it should be adopted now).
In the second part of this blog series, we will look at an effective way to develop plays and apply them to scenarios in Anaplan.
[ii] This incorporates research from an upcoming AFP Guide on Scenario Planning.