The “what if” analysis
for decision-making

Exploring different scenarios to aid in decision-making

By Angela Civitella

Previously published in WestmountMag.ca

In “what if” analysis, a specific type of scenario analysis, you ask a series of “what if” questions to predict potential complications and the impact they’ll have on company operations. As an example, a store owner could ask questions like “What if another luxury clothing store opens on the same street?” and “What if my main supplier goes out of business?” Her questions could help her decide whether she has adequate safeguards in place to protect her if the risks and complications she’s thinking about actually happen.

If another luxury store opens in the same area, what impact can she expect on sales? How will these revised sales figures change her bottom line? Likewise, if her main supplier goes out of business, how will that affect sales and customer service? Are there other suppliers, and how long will it take to set up properly functioning relationships? And if she faces these challenges, how long can she sustain her operations given her cash flow needs?

In “what if” analysis, you ask a series of “what if” questions to predict potential complications and the impact they’ll have on company operations.

There are many questions that you can ask and answer with “what if” analysis. These could be high-level risk management planning questions, or they could be questions that have very specific, measurable impacts. It’s up to you to choose the scope and depth of analysis. You could have a purely qualitative analysis or a purely quantitative one. A typical “what if” analysis is somewhere in the middle, with elements of both.

Qualitative “what if”

As a risk management tool for decision-making, “what if” analysis helps you brainstorm risks and then explore solutions. The store owner’s “what if” questions might include the following:

• What if a competitor opens across the street?
• What if my supply line is suddenly limited?
• What if currency exchange rates change?
• What if the sales tax increases?

‘As a risk management tool for decision-making, “what if” analysis helps you brainstorm risks and then explore solutions.’

The store owner would respond to each question and make sure her business plan includes sufficient contingencies. Thinking further about the first question, “What if a competitor opens across the street?” there are a number of strategic options to investigate, including these:

• Reducing prices
• Defining and marketing to a niche market
• Offering a complementary line of products
• Improving customer service

The store owner can then investigate each of these options and adjust the business plan or model accordingly.

Quantitative “what if” analysis (sensitivity analysis)

A specific form of “what if” analysis, called sensitivity analysis, looks at the effect of changes in the value of estimates or assumptions within an existing model. This asks, “If this value changes, how does that affect the rest of the model?” As such, this type of analysis is typically done with a spreadsheet, and it’s a tool routinely used by decision makers.

In her situation, the store owner might want to know the impact on her bottom line if she had to reduce prices. Using this analysis, she can manipulate sales figures, and learn how much room she has to decrease prices. Likewise, she could look at changes to the spread between her currency and other currencies to ensure that her margins are sufficiently robust to withstand projected changes.

‘A specific form of “what if” analysis, called sensitivity analysis, looks at the effect of changes in the value of estimates or assumptions within an existing model.’

By combining sensitivity analysis with the flexibility of a spreadsheet, the store owner can quickly and easily see the effect on sales, margins, and net income if other inputs are changed. From there, she can determine which changes are significant, and therefore which ones require further investigation and planning. She may assume that an increase in her cost of goods sold is more significant than an increase in the rent for her store. However, a quick sensitivity analysis will allow her to test that assumption.

Step-by-step “what if” analysis

Step one: Define the scope of the analysis
Identify and clearly define the boundaries for the risk-related information you need. Are you interested in the impact of potential risks related to sales? Maybe you want to make decisions related to your investment activity? Or perhaps you want to focus on issues related to staff retention?

Step two: Identify the significant problems to analyze further
The scope of your analysis will be determined by the problems you will want to investigate. For sales issues, you’d likely start with questions related to supply, competition, costs, and demand. With investment activity, you’d focus on changes to interest rates, market conditions, and economic forecasts. Retention questions might look at the ability to offer a competitive wage, the cost of providing training opportunities, and organizational culture.

Step three: Generate “what if” questions for each problem area
Brainstorm hypothetical situations that you believe could impact each issue. What might affect your sales, your investments, or your retention?

• What if costs increase by 5 percent, 10 percent, and so on?
• What if interest rates rise by 1/4 percent, 1/2 percent, and so on?
• What if training costs rise by 2 percent, 4 percent, and so on?

Because your “what if” questions are mostly based on assumptions, it’s also a good idea to test your assumptions. This helps you generate valid questions that are indeed worth investigating.

Step four: Respond to the “what if” questions
Respond to the “what if” questions by investigating further, testing your assumptions, and using sensitivity analysis where appropriate. If the impact is significant in a certain area, you may want to explore that in more detail. Other times, you may decide that the impact is not significant enough to justify more planning and assessment.

It’s also a good idea to analyze the risks you’ve identified for probability and potential impact.

Step five: Use the results in decision-making
After your analysis, adjust your plan appropriately or implement new actions accordingly.

Image: Tim Sheerman-Chase via StockPholio.comOther articles by Angela Civitella
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