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scenario-based planning
What will my
customers value Materialistic
in the future? vs. How and when will new
quality technologies affect
of life markets and production
Will stable growth
return or are difficult Economic processes?
Technology
days ahead? momentum shifts vs.
vs. game
volatility changers
Business
performance
Second tier: Impact of macro-scenarios on business Sensitivity analysis and contingency planning can both be
units After the longer-term scenarios have been used in conjunction with existing scenarios as an input
developed, you then want to dive into how each would for decision making. The purpose of sensitivity analysis
impact the various business units, markets, industries, is to test the impact of specific variables or indicators
etc. Once the potential impacts of each scenario have used in the scenarios. This can be beneficial in evaluating
been identified and the appropriate strategic responses the criticality of indicators being used, as well as the
are defined, each business unit determines what future subsequent impact on the business. Contingency planning
market conditions it will assume and strategy it will adopt. can be used to assess plausible outcomes and impacts of
Competitive strategy will vary and should be tailored based new developments that raise questions about how best to
on the intricacies of each business unit and its market. execute the strategy that is in effect. This type of planning
In a company with many lines of business, the array of focuses on tactical approaches to financial or operational
strategies will be correspondingly diverse. risks identified during the scenario-based planning process.
Phase I Phase II
Define purpose and scenarios Financial impact analysis
Determine the purpose of the scenario- Evaluate the financial impact of each
based planning exercise scenario on relevant areas, including
Develop and define how the scenarios are revenue, earnings, and expenses
going to unfold Collect data and develop a financial model
Determine the strategic direction of the (e.g., econometric model)
business and potential impact of the For each scenario, project financials for the
scenarios established time frame
Phase I Define the purpose, scenarios, and what-ifs concerning events within the eurozone and
associated strategic implications the changes that occur. For example, in Scenario 1, fiscal
As an example of how econometrics can be used in reforms and a series of emergency measures prevent
connection with a scenario-based planning initiative, any national defaults, but the value of the euro falls
consider a U.S.-based multinational manufacturing substantially. In Scenario 2, Greece defaults and it, along
company that is concerned about the implications of with one or several other countries, leave the eurozone,
changes in the eurozone. This particular company has resulting in multiple sets of monetary and economic
manufacturing operations in Asia, while most of the sales repercussions (inside and outside the smaller eurozone).
are generated in the United States and in markets across In Scenario 3, internal dissension causes a breakup of the
Europe. Assume the companys executives decide they eurozone altogether, with a wider range of aftereffects.
want to use scenarios to evaluate the effects of the euro
crisis over the next 12 months. Leadership should be engaged throughout the scenario-
based planning process. It is important to work closely with
The first step to developing your scenarios is determining the key stakeholders who will be using the scenarios and
that the process is properly keyed to the purpose that has econometric model. They will have the strategic insight
been defined. In this case, the focus would be on plausible and wherewithal to determine the future direction of the
downside developments affecting the eurozone over the business given the scenarios. Their input and sense of
next year. ownership is critical to the success of the exercise, as they
will be the people driving the decision making and plan
The number of scenarios can vary, but the range of two execution. Once the scenarios have been defined, you
to four is typically the most manageable. We will assume can work with the business owners and the strategy team
three for the purposes of illustration. Each involves to identify the strategic impacts as the different scenario
storylines unfold.
4,350 14,600
Revenue
Econometric modeling considerations 14,400
4,300
GDP
14,200
Before building an econometric model, you need to 4,250
14,000
consider the various aspects of both the data and your 4,200
13,800
business that could impact results. There are an infinite 4,150 Trough: 13,600
2Q Lag
number of factors and adjustments that can impact a 4,100 13,400
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
model; below are some of the common considerations FY08 FY09 FY10
GDP
GDP
400 14,200
14,000
impacts of each scenario. In our example, the multinational
300
200
13,800 manufacturing company can develop plans to mitigate
13,600
100 13,400
potential revenue loss incurred in each of the eurozone
0 13,200 distress scenarios. It may identify strategies ranging from
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3
FY08 FY09 FY10 FY11 increasing global integration to diversifying its product
portfolio and/or customer base, from reducing cost
Revenue GDP
structure through headcount or process improvements to
changing their marketing strategy. Thinking this through
Log normal data It is sometimes difficult to find provides valuable insights as to how to deal with any of
significant correlation between absolute organizational several versions of the next year in Europe.
performance and absolute economic factors. The
relationship can be more easily established between Through monitoring the current environment as well as
growth in the organization factor and growth in the the forecasts of both the economy and the indicators that
economic factor by converting the data to log normal most impact its businesses, the company can determine
before running the regression. when it would be appropriate to put the plans into effect.
Should events appear to be moving toward conditions
One-time effects There might be a significant one-time, described in one of the scenarios, the company is well
noneconomic event that has an effect on your business positioned to quickly pull the trigger on the appropriate
(e.g., health care reform legislation). Care should be taken predetermined plans to mitigate the negative effects.
to either adjust the organizational performance for this
impact or introduce a dummy variable that mitigates the When you identify and design specific actions to take,
change in behavior of your business over the specific time your company as a whole can be better prepared to react
period. A dummy variable can be thought of as a way to under changing circumstances. Once strategies have been
avoid future growth being based off that one-time event. identified, you can move toward establishing an integration
For example, revenue may spike due to increased work plan and socializing change. You should carefully consider
around the ramifications of the new health care legislation, how you are going to integrate these actions into existing
however, this spike should not be taken as being indicative processes. Adjustments will need to be made to current
of future growth. practices to implement new measures needed to deal with
scenario conditions. Success can depend on how well
Dummy variable: Forecast comparision received the plans are as well as how much ownership key
managers feel they have over the process.
3,500 One-time Differing
3,000 event Forecasts
2,500
Effective socialization throughout all phases of model
Revenue
2,000
development is critical to the effectiveness of a scenario-
1,500
1,000
based planning initiative. Important steps include:
Engage key stakeholders throughout the process
500
Manage expectations of model development and
0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 evolution
FY08 FY09 FY10 FY11
Elicit feedback regarding key issues, strategic
Revenue with dummy variable Real revenue priorities, impact and direction
Develop stakeholders sense of ownership in the
models and scenario plans
Your finance staff can refer to Appendix A on the specifics Work with stakeholders to integrate scenarios into
around creating an econometric model. current processes
Continue to team with stakeholders throughout the
recurring development process
As used in this document, Deloitte means Deloitte LLP and its subsidiaries. Please see www.deloitte.com/us/about for
a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not be available to
attest clients under the rules and regulations of public accounting.
The schematic below provides the process flow for creating a multiple regression econometric model in Excel. This
example will include projecting revenue, however, as stated above, there are many figures that can be projected. The
regression can be done using the LINEST function. While building the model, it is advisable to allow flexibility for future
modifications. For example, include the ability to add additional inputs if needed in future models. The model should also
contain the functionality to adjust the lag and use of economic indicators with ease.
Develop projections
Adjust for seasonality
for economic data
No
Evaluate model statistics
Are model
statistics
appropriate?
Yes
The historical economic data can be obtained from the websites of Bureau of Economic Analysis and Bureau of Labor Statistics.
Bureau of Economic Analysis: http://www.bea.gov/national/nipaweb/SelectTable.asp?Selected=N
Bureau of Labor Statistics: http://www.bls.gov/bls/newsrels.htm#OEUS
This point of view was developed under the stewardship About Strategic Analytics
of Frank Friedman, Chief Financial Officer, Deloitte LLP; The Strategic Analytics group works with U.S. Firm
with subject matter guidance and content contributions leadership to improve the advisory capabilities of Finance
by Carl Steidtmann, Chief Economist, Deloitte Research, and Administration by deploying leading edge tools and
Deloitte Services LP; and Dwight Allen, Director, Strategy capabilities. The priorities of the Strategic Analytics group
Development, Deloitte LLP. Special thanks to those who are chief financial officers priorities and strategic projects,
have provided invaluable feedback on this point of view advanced analytics/data access, and merger & acquisitions
and to Niraj Goel, Global Finance Manager, Deloitte support.
Services LP, for his initial concepts and contributions.
This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial,
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