Google+ Followers

Thursday, February 26, 2009

Scenarios v. Strategies v. Simulation v. Sensitivity

In speaking with a variety of CFOs and risk professionals recently, it seems that there is come confusion over these terms. So before we go any further, let me clarify how I think about these terms. In any business decision, there are things you control (decision variables) and things you cannot control (assumptions).

Scenarios: A comprehensive set of assumptions that tell a consistent story. For example, Obama gets elected, price of oil is under $50, dollar is weak, demand is soft, labor is cheap, etc. would be one scenario. McCain is elected, oil is at $150+, strong dollar, etc. would be another scenario and so on. Scenarios show one possible outcome at a time.

Strategies: A comprehensive set of decisions that tell a consistent story. For example, we will be the low-cost, hi-volume provider in our market using a fast-follower product strategy. Another strategy may be to conserve cash, reduce capicity, protect margine etc. A third may be to spend agressively to gain share.

Sensitivity: This is the worst-best-most-likely scenarios.

Simulations: Simulations simultaneously test all assumptions across a broad range of possibilities. A simulation yields the probability of any particular outcome. This is what Crystal Ball does.

No comments:

Post a Comment