Scenario analysis is a decision-making tool useful to assess how a situation can turn out and how different actions will affect its outcome. This method helps decision makers make informed choices and is widely used by leaders ranging from corporate managers to military leaders. It is especially handy in situations with high stakes and high uncertainty: scenario analysis can help establish the best-case and worst-case scenarios, and sometimes expose outcomes that might have been overlooked.
Herman Kahn is considered the pioneer of this method in his work on military strategy.
Scenario analysis doesn’t tell you what to do, but helps you understand the possible implications and benefits of different approaches. Having all the potential outcomes laid out in front of you can help you make the best decision.
The main drawback of this method lies in the interpretation of its results: how do you decide which scenario is preferable? In addition, the two parameters (uncertainty and impact) can be highly subjective and very difficult to measure.
Different parameters can be used in scenario analysis, and this matrix is best used when tailored to specific situations. However, these parameters can usually be determined along two axes: the level of uncertainty and the impact the action planned will have. Based on this approach, a leader will try to map out what the possible scenarios are in order to determine the best option.
The safe option
Uncertainty is low, which means the leader has a good grasp of the potential outcome of the situation. A low-impact action might be sufficient if it is well targeted. The safe option is an economical management decision made by a leader confident about his/her control of the situation.
In the same circumstances (low uncertainty), a high-impact action will be undertaken in order to exercise caution. Depending on what is at stake and the resources needed to carry out a high-impact action, caution can be a leader’s preferred choice. It can also be a strategic managerial move to take action and show support or authority to employees.
In a situation with high uncertainty, an action with low impact could be a poor choice: the maximum benefit of this action is unlikely to be satisfactory, and leaves a lot to chance. It is a gamble because in circumstances that are widely out of leader’s control, the solution put forward is weak and has a low probability of being successful.
The risky option
In a situation with high uncertainty, high impact decisions can have opposite effects. It is risky because of the lack of control a leader has on the outcome, but the scale of the action is commensurate with the problem and provides a winning solution in the best case scenario. It is the trickiest situation, when a important action is necessary, but can have an either beneficial or adverse impact on the situation.