Cornelius, P. , A. van de Putte and M. Romani (2005), Three decades of scenario planning in Shell This paper of Peter Cornelius (Cornelius, P. , A. van de Putte and M. Romani (2005), ) focuses on the external environment in which companies operate. Changes in this business environment can create risk/challenges or create important new opportunities. Forecasting the future, usually based on the assumption that tomorrow’s world will be much like today’s will provide an inappropriate tool to anticipate shifts in the business environment.
Shell uses scenario analysis which are not projections, predictions, or preferences; rather, they are coherent and credible alternative stories about the future. These scenarios will enable managers to (1) help identify options in the future, (2) help time the decision to exercise the real option and (3) can provide an important input in the process of evaluating it. Scenario planning differs fundamentally from forecasting in that it accepts uncertainty, tries to understand it, and makes it part of the reasoning. Scenarios help prepare for a range of alternative and different futures.
A scenario focuses on different instead of one outlook on the future. 1. No single strategy can perform best in all scenarios. 2. Create awareness among managers about external uncertainty (fundamental difference). 3. Learn how to act upon or react to future developments 4. Combine qualitative and quantitative 5. Stretch managers mental models. Scenarios at Shell have developed over time from rather simple to more complex models based on volumes of oil, energy and socio economic trends. An increasing number of variables has been integrated.
The latest scenarios developed by Shell are (1) Low Trust Globalization, (2) Open Doors and (3) Flags. Shell has a track record in anticipating major structural changes in the global energy markets has substantially enhanced the credibility of scenario analysis within the Group. Although not all scenarios were adequate (underestimate importance of global terrorism), it can be argued that this approach has performed better than traditional forecasting. Below the examples of the Shell scenarios in the past decades: The process of defining the scenario can be found below.
In Exhibit 3, this will start in the external environment (DESTEP) and narrows down to consumer demand (marketplace wants and needs). After this the competition is analyzed together with potential risks. The Global scenarios have helped Shell to gain competitive advantage. These scenarios were designed to help the company formulate its overall tactical and strategic policies and permit management to explore new ideas by shifting the company away from “group-think” over time focused scenarios have gained in importance. Typically, these scenarios deal with country-specific issues or individual projects.
These so called focused scenarios allow management to gain insights at a lower level (SBU or project). Selection projects by using real options has several advantages. The belief in a single outcome can lock us into a narrow set of options, a risk that scenarios can help to mitigate by discovering the full range of pathways. Especially in making financial project decisions the real options approach is a way of thinking that helps managers formulate their strategic options (the future opportunities that are created by today’s investments) and potential value.
This tool is useful where uncertainty is high and for this reason calculating the Net Present Value (NPV) or Discounted Cash Flow (DCF) is an unreliable estimate. It is important to mention that for some markets a problem lies in the limited guidance that history can provide for the future and high volatility. There are two main factors that affect future payoffs and explain why these differ from past payoffs. (1) factors affected by the firm’s decisions are usually project- or sector related and are generally easy to identify. (2) Other factors may be outside the firm’s control (DESTEP).
Real options analysis are especially suitable for staged investment decisions in highly uncertain environments. An example is given of a 5-stage approach in which each stage can be seen as a call option on the value of continuing with the exploration, a value that includes the value of all future options. Scenario planning emphasizes the importance of mapping causal linkages among different factors that may or may not be outside the firm’s control. Of course, scenarios, as stressed earlier, are not forecasts, and the can be used in the strategic planning rocess only in conjunction with specific tools to select individual projects. In some cases this could have lead to rejecting an investment based on DCF analysis where a real options analysis combined with scenarios could have come to a different conclusion. Summary Cornelius introduces scenario planning as a method that is suitable for strategic planning in highly uncertain environments. This method will provide managers with a number of possible futures by considering multiple variables in the model.
Scenarios are developed at different levels within an organization (global, focused and project). This approach would lead the manager away from groupthink and explore new ideas. At a project level the real options approach is useful as a projects value may change over time die to the introduction of new information. These scenarios will enable managers to (1) help identify options in the future, (2) help time the decision to exercise the real option and (3) can provide an important input in the process of evaluating it.