Your website crashes on Black Friday. A viral TikTok wipes out your inventory overnight. New tariffs raise your costs without warning. A supply chain disruption delays your new product for months.
Even with careful planning, these surprises happen. Scenario analysis helps you prepare by asking “what if” and mapping out responses before you need them. Whether it’s supply chain disarray or an unexpected sales surge, you’ll have a plan ready.
Here’s how to use scenario analysis to stay ready for whatever comes next.
What is scenario analysis?
Scenario analysis is a strategic planning technique where you explore various future outcomes based on shifts in economic conditions, market performance, or regulations. You develop plausible scenarios—a best case, worst case, or base case—and estimate how each would affect your finances and business operations.
For example, a brick-and-mortar clothing boutique might analyze three scenarios:
1. Worst case. A fast fashion chain opens in the same shopping center.
2. Best case. The store secures an exclusive brand partnership with a popular sustainable label.
3. Base case. Foot traffic remains steady.
The store can then compare each scenario’s impact to inform more resilient decisions.
A complement to scenario analysis is sensitivity analysis, which considers how much influence multiple variables have on outcomes.
Scenario analysis vs. financial forecasting comparison
Scenario analysis explores a range of different outcomes. By contrast, financial forecasting usually projects a single most likely result based on current trends. Both tools help you plan for the future, but scenario analysis complements forecasting by showing what could occur under different conditions (beyond a single main prediction). A forecast based on your financial model might predict a 10% increase in holiday sales; scenario analysis might also imagine a supply delay that reduces sales.
How scenario analysis works
Scenario analysis works by pinpointing the key factors affecting your business and then envisioning how changes in those factors could play out. Start by choosing a specific area or event to examine (like a holiday sale) and then adjust variables (demand, costs, or traffic) in each scenario. Project the outcomes—sales, expenses, cash flow, or changes in your business’s net present value—for each case and compare them.
Here’s how that modeling might look when thinking about holiday sales, for example:
- Base. The base scenario (sometimes called the basic case or baseline case) is your anticipated outcome if everything continues as usual. This scenario assumes business conditions stay within a historic range. The retailer’s base case may assume holiday sales grow modestly at about 5% to 10%, similar to last year’s performance.
- Worst. The worst-case scenario is a pessimistic outlook, where things go wrong. It might be that a major carrier warns of delivery delays during the peak holiday season, forcing you to offer refunds on pre-orders to disappointed customers, leading to a 10% drop in holiday sales.
- Best. The best case is your ideal projected scenario where everything goes better than expected. You consider future events like robust market performance or out-of-the-blue buzz. For instance, a widely shared TikTok review could drive unexpected traffic, causing holiday sales to jump by 50%.
Scenario analysis mini case study: Reparations Club
Jazzi McGilbert founded Reparations Club, a Los Angeles–based bookstore and creative outlet that features books from Black and minority authors. Starting with just $20,000, McGilbert built what became a seven-figure business within three years by creating an in-person community rather than developing products. McGilbert’s business plan centered on realistic worst-case scenario analysis rather than optimistic projections.
“If I sign this lease for a year, I know what the rent is. If nobody walks in this space and buys anything, how much do I stand to lose?” she said on an episode of the Shopify Masters podcast. “And so that was my business plan. I was prepared to lose it all. And I didn’t.”
This type of scenario planning can free you to take the calculated risks that build businesses. Sometimes the most powerful planning question is simply, “What’s the worst that could realistically happen?”
Pros and cons of performing a scenario analysis
Scenario analysis is a risk management tool that helps you identify conceivable issues before they become problems. Here are some benefits of performing scenario analysis:
- Ready for busy seasons and quiet periods. Planning alternative scenarios forces you to think ahead about both high-demand times and slow spells. You’ll be prepared with enough inventory and staff for holiday rushes, and you won’t panic during off-season lulls.
- Fewer surprises, less stress. In theory, if you’ve already thought through worst-case situations, fewer things can catch you by surprise. Ideally, you have a game plan ready instead of reacting on the fly.
Anticipating different outcomes helps you eliminate blind spots and make more considered decisions, but there are a few caveats. Here are the cons of performing a scenario analysis:
- It takes time you don’t always have. Scenario planning takes time. Mapping out multiple scenarios requires research and number-crunching—time you might need for daily operations.
- Bad data can lead to incorrect assumptions. Scenario analysis is as good as your predictions and the data behind them. If your inputs are flawed or based on outdated data, your scenarios will be off-target and could lead to poor decisions.
- You can’t predict everything. No matter how much scenario modeling you do, real life can still throw something unexpected—say, a global pandemic shutting down retail or a huge container ship blocking a major shipping route.
How to conduct a scenario analysis
- Pick your scenario planning focus area
- List your biggest what ifs
- Imagine a few different scenarios
- Model the scenarios
- Plan what you would do in each case
- Update your scenarios as conditions change
To conduct scenario analysis, focus on one area at a time, brainstorm what could go right or wrong, then map out the potential impact and how you’d respond. Here’s how the scenario analysis process works:
1. Pick your scenario planning focus area
You can’t model everything, so narrow your focus. Start by choosing the specific area of your business or future event that you want to build scenarios around. Defining the target of your scenario analysis gives you a set of facts that’s easier to manage.
Here are example scenarios:
- Future seasonal sales event. Planning for a spring sale or a Christmas rush.
- New initiative or launch. Rolling out curbside pickup or a new product release.
- Market expansion. Entering an online marketplace or opening a pop-up shop.
2. List your biggest what ifs
Once you have a focus, brainstorm major “what if” questions related to that area. Identify the handful of key factors and possible scenarios for your business. You don’t need to create scenarios for every tiny possibility.
Consider how your business might need to anticipate external factors such as unexpected economic shifts, increased interest rates, or changes in consumer spending patterns. Here are a few hypotheticals to consider:
- Demand fluctuations. What if a negative review from a major influencer tanks sales for your bestselling item? What if new health research makes consumers avoid your product entirely?
- Supply or operational issues. Could cybercriminals hack your point-of-sale (POS) system? Might your third-party logistics (3PL) provider decide to cease operations?
- External changes. What if new tariffs increase costs? Or, on the bright side, a competitor shuts down and its customers seek you out as an alternative?
3. Imagine a few different scenarios
Apply your what ifs to build out a few possible outcomes. At a minimum, create three scenarios—a base case (the most likely outcome), a worst case, and a best case—based on different combinations of variables.
The worst-case scenario might combine several negative events (e.g., low demand plus supply bottlenecks), while the best-case scenario combines positive factors (e.g., high demand and efficient operations).
Develop scenarios based on commonly accepted assumptions about your industry and conceivable market conditions—not outlier events. You can also opt to assign probabilities to scenarios to weigh your planning decisions.
4. Model the scenarios
Next, work out the details of how each scenario could affect your business metrics. Plug the scenario’s assumptions into your financial model or planning spreadsheet using inputs like historical data and market research. Most businesses can run effective scenario analysis using basic spreadsheet software, but consider planning tools like Workday Adaptive Planning or Anaplan.
Calculate the impact for each scenario. How would your expenses, revenue, profit, inventory levels, staffing, and cash flow look under these conditions?
For a product launch, you might outline the following potential outcomes:
- Base-case scenario. Sales mirror your last product launch with a 10% sales increase for two months before returning to normal baseline levels.
- Worst-case scenario. Manufacturing delays push your launch back six weeks into a slower sales period, while a competitor releases a similar product first, resulting in sales falling 30% below your baseline projections.
- Best-case scenario. An unexpected product review from a popular Substack newsletter generates buzz, driving sales 75% above your baseline for four months and garnering strong brand recognition for future launches.
Doing the math for each potential outcome gives you a clear picture of the best and worst that could happen—as well as somewhere in between.
5. Plan what you would do in each case
Once you see the numbers and ramifications of each scenario, do contingency planning for each. In your worst-case scenario, you might project how a loss of revenue affects your cash flow, inventory turnover, ability to make payroll, and marketing budget. How are you going to deal with that? You might prepare cost-cutting measures, backup suppliers, or emergency financing to survive the downturn.
For a best case, you might plan how to scale up quickly—perhaps by securing extra inventory or staff to handle the boom. The goal is to develop contingency plans so that whether things go south or head sky-high, you’re not scrambling.
6. Update your scenarios as conditions change
Revisit and edit your scenario analysis periodically or when major changes occur. If new information comes in—like a new law that benefits your industry, or disappointing sales data—update your assumptions accordingly. Running multiple scenario analysis exercises throughout the year for different seasons, product launches, or market conditions keeps your planning sharp.
Scenario analysis FAQ
What is meant by scenario analysis?
Scenario analysis is a risk management tool where you evaluate your business under different future possibilities. Scenario analysis involves thinking through what-if scenarios like new compliance mandates that drop without warning, interest-rate swings that impair cash flow, or a rival’s sudden change in strategy—then sketching out a plan for each one.
What are the three scenarios in scenario analysis?
The three common outcomes modeled in a scenario analysis are a worst-case, base-case, and best-case scenario. The worst case is an unfavorable outcome (e.g., low sales), the base case is the expected or most likely outcome, and the best case is one in which everything goes better than expected.
How do you write a scenario analysis?
To write a scenario analysis, focus on the area to examine, then outline a few different scenarios around it (including their key assumptions). For each scenario, describe what happens, run the numbers to project possible outcomes, and state the actions to take if that scenario occurs.
What is a scenario analysis example?
One example of scenario analysis is planning for a retail product launch and the possible outcomes. You might model a baseline scenario in which your waterproof backpacks sell as expected, a worst-case scenario where supply chain issues cause sales to fall about 30% short of your projections, and a best-case scenario where a celebrity endorsement doubles demand. Then forecast the scenario analysis results and plan how to handle each situation accordingly.
