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40 visualizzazioni18 pagineBrauers&Weber - A New Method of Scenario Analysis for Strategic Planning

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7, 31-47 (1988)

Strategic Planning*

JUTTA BRAUERS**

MARTIN WEBER*'

Aachen University, FRG

ABSTRACT

We first present scenario analysis as a qualitative forecasting technique

useful for strategic planning. Then we develop an overview of the two

classes of methods for scenario analysis described in the literature. Based

on both classes, a new method is developed which especially fits the needs

of strategic planning. The method can be divided into three stages: 1.

Determination of compatible scenarios, 2. Determination of scenario

probabilities, and 3. Determination of main scenarios. An example is given

to illustrate the method.

KEY WORDS Scenario analysis Cross-impact analysis

Strategic planning

Strategic planning, the major building block of strategic management, has the goal of guiding

and coordinating the long-term development of an organization and its environment (Trux and

Kirsch 1979). Because planning is directed towards the future, predictions are indispensable

components of planning and doubtless the most important form of information that can be

produced and used in the planning process (Wild 1981). New demands for forecasting methods

have arisen as changes in the planning process in organizations lead to increasing emphasis on

the strategic aspects of the planning process.

More traditional methods, i.e. quantitative forecasting methods such as time-series analysis,

try to extrapolate new ideas about future developments based on knowledge of and experience

with the past and present (Makridakis and Wheelwright, 1978, Opitz 1985). These methods

usually imply that frameworks developed in the past are also applicable to the future, and rarely

use the qualitative, subjective knowledge of local managers involved. However, extrapolation

can easily allow one to overlook new opportunities and risks facing the organization, especially

in times of rapidly changing internal and external conditions. What is needed are forecasting

techniques which address the special requirements of strategic planning to supplement

traditional methods.

'This paper is based upon an earlier publication, 'Szenarioanalyse als Hilfsmittel der strategischen Planung:

Vlethodenvergleich und Darstellung einer neuen Methode. Zeiischrift fUr Beiriebswirtscha/l, volume 56 (1986).

**Lehr-und Forschungsgebiet Allgemeine Beiriebswirtschaftslehre, RWTH Aachen, Templergraben 64, D-5100

Aachen, West Germany.

0277-6693/88/010031 -17$O8.5O

Received February 1987

1988 by John Wiley & Sons, Ltd.

Revised July 1987

32

Journal of Forecasting

We would like to propose scenario analysis as a forecasting method to support the strategic

planning process. We consider a scenario to be a description of a possible future state of an

organization's environment considering possible developments of relevant interdependent

factors in this environment. We can find analogous definitions in the literature (see for example,

Becker, 1983; Geschka and von Reibnitz, 1979; Godet, 1983; Oberkampf, 1976; Sarin, 1978).

Scenario analysis techniques characteristically synthesize quantitative and qualitative

information, constructing multiple scenarios or alternate portraits of the future (von Reibnitz,

1981). The experience and intuition of the manager will be reflected in the qualitative

information used.

To illustrate, let us contrast scenario techniques with the more traditional quantitative

forecasting methods. While the latter conceptually deal mostly with the existence of a single

future state which they predict, scenario techniques attempt to ascertain alternative future

states and calculate their probabilities (i.e. the probability we can assign now to their future

occurrence). Put into decision theory terms, scenario techniques are a strategic planning tool

for decision making under risk (i.e. choosing among strategic alternatives,) for determining

possible future environmental situations and their probabilities. Since the future-oriented

scenario techniques should operate without making direct extrapolations from past situations

and frameworks, they require the consideration of qualitative, subjective information requiring

the close collaboration of management in the building of scenarios.

Once we have determined a set of possible future states using scenario techniques, these

scenarios can be included in different phases of the strategic planning process (Becker, 1983;

Gomez, 1982; von Reibnitz, 1983; Wilde, 1982). They can now form a basis for the evaluation

and selection of potential strategies, i.e. we can now produce an estimation considering the

probabilities and risks involved with each individual strategy. In the simplest case, in every

scenario the same strategy will have a higher objective function value when compared to

alternative strategies and therefore will be chosen. The different scenarios will demonstrate de

facto, the way to its success or failure. If we monitor certain aspects of the scenarios with an

'early warning system' we may be able to recognize any potential failures and may be able to

avoid them entirely. Another advantage of scenario techniques arises in large organizations,

where planning is at least partially decentralized. Here scenarios represent the results of a

coordination process for determining possible future states, i.e. they represent a common basis

for further planning within the organization.

There are primarily two types of scenarios. The first are 'corporate scenarios* which are

developed internally, targeting a specific goal or problem of the organization. Scenarios

entitled, for example, 'Our Company in the Year 2000' a sales or marketing scenario, would

fall under this category. The second type of scenarios are those which are not tailored to a

specific concern of an organization. These include so-called 'world scenarios' (Kahn and

Wiener, 1967), 'energy scenarios', scenarios concerning an entire sector (Rao, 1984) and traffic

scenarios (Mitchell et al. 1979).

Although these latter scenarios have enjoyed almost twenty years of increasing popularity,

the corporate scenarios we consider in this article have only recently entered the realm of

strategic planning. In an empirical study Linneman and Klein (1983) determined that prior to

1974, only a few American companies used scenario techniques in their planning process. A

survey conducted in 1981 found that 108 out of 215 responding Fortune 1000 companies used

scenario techniques. Malaska et al. (1984) conducted a similar study in Europe sending out 1100

surveys, from which 116 answers were received, 36 per cent of which indicated the use of

scenario techniques. Only 12 per cent of these companies used this methodology before 1973.

33

Eighty-three percent of those who use scenario techniques support the premise of this paper,

that they are a useful element of the strategic planning process.

Outline

Although scenarios are an important tool in the strategic planning process, and are increasingly

used in the business world in this capacity, there is no single generally accepted method for

constructing them. We can summarize the requirements of scenarios in the planning process as

follows. Their purpose is to reflect possible alternative developments which are constructed

using quantitative data as well as the experience and intuition of managers. Existing

interdependencies between future developments must also be considered. Practically, between

two and tour scenarios should be produced, along with a current starting assessment of their

likelihoods considering the possible future states of their environment.

Selected methods of scenario development from the literature are discussed in light of these

requirements. In the following sections a new procedure is presented which meets the

requirements described above. Finally, an example using this new procedure is given.

SCENARIO ANALYSIS METHODOLOGIES: DESCRIPTION AND COMPARISONS

Scenario analysis consists of three basic stages (see, for example. Gomez and Escher, 1980):

analysis phase; description of future states of environmental subsystems; and synthesis phase.

In the first stage, the analysis phase (von Reibnitz, 1981), we will come up with an exact

definition for the entity of our investigation, so that all participants in the analysis have a

similar understanding of the problem at hand. Based on this consensus the problem can be

further bounded and structured.

The problem analysis is followed by a subsystem analysis which consists of the identification

of relevant external influences (the environmental subsystems) on the entity being investigated.

Possible subsystems include 'the economy' "raw material acquistion' 'the working world'

'society' and 'technology' From every subsystem we choose a few representative influencing

factors relevant to the problem at hand. For 'the economy* we might determine that 'economic

growth' is one representative factor, for 'society we may indicate 'dominant political opinion'

To aid us in the analysis phase we should employ a variety of creative methods (such as

morphological analysis, brainstorming, brainwriting, and the delphi technique).

In the second stage of scenario analysis we define possible development paths of the

influencing factors already discussed. In the third stage we consider the existing

interdependencies between the factors and establish alternative scenarios through the synthesis

of these different future states. There are two basic methodologies for implementing the second

and especially the third stage of scenario analysis. One, the 'cross-impact analysis' technique,

is primarily used and presented in English-language publications. The other, the 'Battelle

method' from the Battelle Institute in Frankfurt, is primarily a German approach.

Cross-impact analysis

Cross-impact analysis techniques (Gordon and Hayward, 1968; Sarin, 1978, 1979) make

assumptions about the future developments in the environment of an organization, in which

certain events influencing the entities under investigation are identified and either occur ( = T )

or do not occur (= '0'). Methods used in this third stage of scenario analysis range from the

interpretation of the literature, to conventional forecasting techniques (for example trend

extrapolation), to the creativity techniques previously used in the analysis phase.

34

Journal of Forecasting

Starting with a finite set of events e,(/= 1,.... /i) scenarios consisting of combinations of

occurring and non-occurring events are constructed in the synthesis phase. Additional

information must be specified (Jackson and Lawton 1976; Dalkey 1972): (1) the marginal

(absolute) probability pii) (the probability that event et occurs) and (2) estimates of the

interdependencies between different events in the format of a cross-impact matrix.

In older cross-impact analysis models (Wechsler, 1978; Welters, 1977; Duval et al., 1975),

these interdependencies (cross-impacts) were estimated as likelihood ratios. By using the

cross-impacts we can transform the marginal probabilities pii) into conditional probabilities

pii\j) (the probability that event e, will occur given that event ej has occurred). Each scenario

will be constructed by simulating occurrence or non-occurrence for every event in the event list,

and for the rest of the events, through probability transformations based on cross-impacts.

After many simulation runs, the relative frequency will determine the probability of each

scenario (Martino, 1972; Mertens and Plattfaut, 1985).

More recent approaches employing cross-impact analysis have modelled the

interdependencies directly in the form of conditional probabilities pii\j)By using

programming methods and/or systems of equations, scenario likelihoods or bounds are

determined from the marginal and conditional probabilities. We shall continue by looking at

the two most recent methods for the determination of the scenario probabilities, the interactive

models by Sarin (1978, 1979) and by De Kluyver and Moskowitz (1984). Both models use the

following notation: the combination of n given events ei

en, produces N = 2" scenarios

(see Table 1).

The likelihood or probability of a scenario is designated by the variable ys, the column vector

of the scenario probability by y, and the corresponding transposed probability vector by y'

The 'O'/'l' column vector in Table 1 are abbreviated as ai,...,an.

Table 1. List of scenarios

Event

Scenario

1

2

Probability

yi

7V-1

N

T : Event ei occurs

e2

*/I ^ L

en

1

1

1

1

1

1

1

0

0

0

0

0

0

0

1

0

Sarin's Modei

Sarin (1978, 1979) determines scenario probabilities interactively. If experts estimate only

marginal probabilities pii), then the limits for the joint probabilities pii'j) or conditional

probabilities pii \ j) can be calculated for these experts using standard probability theory.

ipii'J) = pi'\J)' PiJ) is defined as the joint probability that events e, and ej both occur.)

Experts can then supply additional estimates within these particular limits. When all

probabilities pii) and pii'J) have been determined, the bounds for further joint probabilities,

firstly those for the next level pii'j-k), can be calculated and in turn used by the experts. This

interactive procedure should be continued until the final estimate of the joint probability

2'... /I) has been determined.

35

From Table 1 we see that the marginal and joint probabilities can be expressed in the form of

scenario probabilities and therefore can lead to the following system of linear equations: (Note

the ' ' operation produces a vector of components where each component is the product of the

respectively indexed components of the vectors being operated upon.)

y'-ai

=Pii),

i=l,...,n

= Pii'J-k),

y'-iai'...

an)

=p(l

/= \,...,n-2,

j>

i, k> j

...-n).

The following relationship must hold for all scenario probabilities ys'.

N

YJ

ys-A'

5 = I

Since all terms on the right-hand side of these equations are specified by Sarin's interactive

procedure, we can now calculate the scenarios' probabilities. This allows us to order the

scenarios and to select probable scenarios for further analysis.

De Kluyver's and Moskowitz's Model

For this model (De Kluyver and Moskowitz, 1984), experts must estimate the conditional

probabilities pii\J) in addition to the marginal probabilities pii). Since estimation of the

former often ends up violating axioms of probability theory, they introduce final, theoretically

accurate conditional probabilities p*(/ j J) which fulfill these axioms. The 'difference variables'

dij and dij measure the difference between the theoretically accurate and the estimated

conditional probabilities p*ii \ j) + dij- dij = pii \ J), where p*(/1 f) and pii \ J) both must lie

within the bounds pii | J)~ and pii\ j)* respectively. The maximum of all individual difference

variables is represented as '</'

The object of this method is to determine a starting solution for the variables ys,p*ii | j), dij

and dij. To do this we must minimize the maximum difference between the theoretically

acceptable and the elicited conditional probabilities:

min d

subject to:

(0.

y' ai

y''iai'

aj)

= P *0|y)- PU)

-I

s = I

pOlyr

p\i\ y) ^ pi[i\J)

O^dJ,

+ ^a!

The interactive nature of this procedure is employed only after the starting solution has been

determined. The decision maker can now suggest corrections, the effect of which can be

examined by a sensitivity analysis.

36

Journal of Forecasting

The Battelle method (Geschka and Reibnitz, 1979; Oberkampf, 1976; von Reibnitz, 1981, 1983)

arises from a different way of defining future states of the environmental subsystems. Here,

factor outcomes (alternate future states) for the critical factors (the subworld representations

which do not have one clearly defined future state) are specified mutually exclusively but

exhaustively. If we try to determine possible outcome values for, for example, the societal

factor SI: 'dominant political opinion', then the following list of mutually exclusive but

exhaustive outcomes could result: Sll: 'socialist' S12: 'liberal' or S13: 'conservative'

In the synthesis stage, individual compatible outcomes will be combined into a single bundle

free of contradictions. The Battelle method explicitly does not use probabilities. To determine

the interdependence between the individual outcomes, experts are asked how compatible the

outcomes e, and ejij = 1,...,) are. These subjective estimates give us a 'compatibility matrix'

comprised of compatibility values kij which take on integer values from 1 to 5. If two outcomes

are incompatible they are assigned the value 1. A compatibility rating of 5 indicates that they

are very compatible. The inbetween values 2, 3 and 4 represent increasing compatibility. Since

this compatibility matrix is symmetric, ikij = kji), it can therefore be represented as a triangular

matrix. This matrix can be programmed onto a computer and used to prune the number of

possible outcome combinations (scenarios) down to the number of compatible scenarios. A

scenario is considered compatible when none of its outcome pairs ikij) has a value of 1. This

further analysis should be applied to between three and five selected scenarios which have a high

internal compatibility rating, but which are externally dissimilar to one another (Reibnitz,

1981), thus covering the range of plausible scenarios.

Comparison and evaluation of the proposed methods

Cross-impact analysis requires marginal and conditional probabilities for the pairs of events as

input. High demands are therefore placed on the decision maker's ability and willingness to

make estimates. Since these estimates often do violate probability theory axioms, consistency

tests and corrections are often required (Dalkey, 1972; Duval et al., 1975; Sarin, 1978).

Cross-impact analysis outputs a ranking of scenarios in order of their likelihoods. Since these

probabilities are often very small (Duperrin and Godet, 1975) it is suggested that individual

scenarios be grouped together (Martino and Chen, 1978).

The Battelle method, contrasting with cross-impact analysis, requires much simpler input:

the compatibility estimates for every possible pair of factor outcomes. The output is a range of

compatible scenarios and their average compatibility values (or weights). Since the Battelle

method does not employ probabilities and only certain individual scenarios are chosen for

further investigation, it is possible that scenarios will be selected which have starting

probabilities so small that these scenarios cannot practically be the basis of a meaningful

planning effort.

Before we present this new method of scenario determination, we should describe the input

requirements and the resulting outputs. We adopted the position of the manager who, we

suggest based on our experience, is not very interested in the mathematical aspects of a

scenario's analysis.

Analogous to the methods described above, we will assume that factors, factor outcomes and

compatibility values (1-5) have been defined in earlier stages of the scenario analysis according

37

to the Battelle method. Here the factors are the relevant external factors which influence the

problem. The factor outcomes are possible future states of the factors. The compatibility values

represent estimates of the interdependencies existing between individual outcomes. Of course it

would be theoretically advantageous if these interdependencies were described as conditional or

joint probabilites; however we want to keep the information demanded of managers as simple

as possible. As mentioned previously, a critical factor in cross-impact analysis is its need for

estimates of the conditional probabilities (Mitchell and Tydeman, 1978). An empirical study by

Moskowitz and Wallenius (1984) showed that, depending on the format of the survey questions

used, up to 50 per cent of all estimates of conditional and joint probabilities violate simple

axioms of probability theory. For a study of improving the consistency of conditional

probability assessment see Moskowitz and Sarin (1983).

Our method also requires marginal probabilities on the occurrence of factor outcomes. Since

every factor usually only has two or three outcomes, these probabilities are easy to determine

(Spetzler and Stael von Holstein, 1976). If this determination of probabilities is too difficult for

managers, the estimation could also be done by other experts, or one could assume that all

outcomes of a factor have equal probabilities.

As a result of our method, managers obtain a number (usually two to four) of alternative

mafor development directions (scenarios) and their respective probabilities. This creates a basis

for further stages of scenario analysis, and therefore for strategic planning.

The following methodology can be split into three stages:

(1) determination of compatible scenarios;

(2) determination of scenario probabilities through linear programming and

(3) determination of some main scenarios using cluster analysis

In the second stage we will determine the probabilities for possible combinations of factor

outcomes (scenarios) based on their (marginal) probabilities and their compatibility values. For

this we will further develop De Kluyver's and Moskowitz's model described earlier. Since

determining scenario probabilities for normal-sized problems is already cumbersome due to the

sheer number of computations necessary (our example will require a linear program with

approximately 600 variables and 500 constraints), we will be determining all compatible

scenarios in stage 1 using an enumeration procedure. In larger problems these compatible

scenarios, or at least a portion of them, will provide the starting data for stage 2. This is based

on the hypothesis that typically very small probabilities (or even ys = 0) would be determined in

the second stage for incompatible scenarios with non-extreme marginal probabilities. In stage 3,

we will use cluster analysis to synthesize the selected scenarios into a few main scenarios. The

probability of a main scenario is calculated as the sum of the probabilities of the scenarios from

which it is comprised.

The three stages of this method have been implemented in the computer system

'KONMACA' (compatible scenario, matrix generator for linear programming, cluster analysis

von Nitzsch et al. 1985).

Determination of compatible scenarios

Based on the compatibility matrix developed in the Battelle method (i.e. on the factor outcomes

and the compatibility values), the compatible scenarios are determined in the first stage of our

procedure. These scenarios are found through simple bounded enumeration of all possible

combinations of factor outcomes. Every combination is checked to see if its outcome pair has

the compatibility rating of 1 assigned to it. If so this combination will be classified as

38

Journal of Forecasting

programming implementation see von Nitzsch et al., 1985.)

With larger problems it is possible that so many compatible scenarios will exist, that for

economic reasons only a subset (practically less than 50) can be considered in stage 2. In these

cases we would try to choose the scenarios with the fewest number of compatibility ratings of 2

and/or which have the highest average compatibility values. We do this because, if we assume

non-extreme marginal probabilities, both of these selection criteria tend to exclude only

scenarios with typically very small probabilities.

Determination of scenario probabilities using iinear programming

After the first step, where the number of possible scenarios is reduced to the number of

compatible scenarios, and in some cases, further pruned to a subset of these, the decision maker

has the option to reintroduce any especially interesting scenarios which were excluded due to

their deemed incompatibility.

The probabilities of the selected scenarios are determined by the use of a linear programming

model (referred to hereafter as LP), which is based on the De Kluyver and Moskowitz model

discussed above.

De Kluyver's and Moskowitz's procedure requires marginal and conditional probabilities.

On the other hand, in addition to the marginal probabilities, our procedure only needs simple

compatibility estimates of the outcome pairs. Since these compatibility estimates are integers

between 1 and 5, they must be transformed into probabilities before the LP can use them to

calculate scenario likelihoods. To do this we have two options: we can translate them (1) into

conditional probabilities p(i \ j); or (2) into joint probabilities p(i' j). We reject the first option

because the symmetry of the compatibility matrix tells us that k,j = kji and therefore would also

apply to the conditional probabilities p{i\ j) = pU\ ') This condition is only fulfilled when

p{i) = p(j), i.e. when all marginal probabilities of the individual outcomes for each outcome

pair are equal. The second option has the advantage that there is symmetry between the joint

probabilities, i.e. pii-J) = p(j- i). In the first part of the second stage, the compatibility values

kij will thus be transformed into similar joint probabilities p(i -J). The upper and lower bounds

of these joint probabilities p(i-j) will be calculated (Stover and Gordon 1978) according to

probability theory axioms, and thus:

These bounds are illustrated in the following example. If /?(;) = 0.7 and pij) = 0.8 then the

joint probability pii'j) cannot be 0.4 because this would violate the lower bound of

l,j = 0.5 ^ pii'j). Alternatively, the joint probability cannot be 0.9 because of the upper bound

Uij =

0.1^pit-j).

The transformation of the compatibility values k,j into joint probabilities pii'j)

follows:

is done as

This equation is based on the concept of splitting the difference between the upper and lower

bounds of the joint probabilities according to the compatibility ratings. If kij = 1 then the joint

probability p(i-j) will take the value of the lower bound /,>; if kij= 5 then pii'j) - Uij. The

preceding equations give us the folJowing results:

kij= 1 - pii'j) = lij (in the example: 0.5);

kij = 5 - pii'j) = Uij (in the example: 0.7);

1 < /Cy < 5 - lij ^ pii -j) ^ Uij.

39

However, these equations are linear interpolations over the range from 1 to 5 and have the

disadvantage that if ku = 3 then it is possible that pii-j) ^ pii) - pij). To avoid this we could

make the following change:

/?(/ -y) = Pii)' PiJ) + I iuu - Pii) - PiJ)) - iku - 3)/2),

where kij ^ 3 with a respective equation for A: ^ 3. This gives us two linear interpolations, for

1 ^ A: ^ 3 and for 3 ^ A- < 5.

The joint probabilities pii-j) calculated using the equations above are entered into the LP as

so-called preliminary joint probabilities. They are referred to as preliminary probabilities

because they generally violate another important condition and therefore will eventually have to

be corrected. This condition states that the probability of each outcome must be equal to the

sum of the joint probabilities for this o.utcome, and every other outcome both occurring and

not occurring pii) = pii-j) + pii' ~ j), where pii- ~ j) is the joint probability that outcome

ei will occur and that ej will not. From this we can establish afinaljoint probability p*ii'j) for

the determination of the scenario probabilities, which fulfills the conditions

pii) = P*ii'j) + P*ii' ~- y)i and whose distance from the joint probability pii'j) is measured

using the difference variables dfj and du. The objective of this LP model is to minimize the

difference between preliminary and final joint probabilities, where the scenario probabilities

will be determined as by-products. (For an overview of goal programming see Ignizio, 1976.)

The LP model has the following form for K selected scenarios:

min Y.uidiJ+ dij) + M-d where A/ is a large value, say 10,000

subject to:

(1) y''ai

il) y''iai-aj)-p*ii-j)

^ pii),

^0

(3)

^1

(4)

IJ

ys

(6)

d-di}

il)

d- dij

ys,dij,di},d

= Pii'j)

;

'

;

Objective Function: The variable d is equal to the maximum of all individual difference

variables dj and dij. Becaus'e of the relatively large objective function coefficient d, first the

maximum difference between the preliminary and final joint probabilities is minimized and then

the sum of the individual deviations is minimized. Our objective function therefore combines

two alternative objective functions: minE(flfy-i- dy) and min d.

Constraints (1) and (2): This could be illustrated in a small example where we have two factors

(A and B), each with two outcomes (Al, A2 and BI, B2) and one factor (C) with three resulting

outcomes (C1,C2,C3). These outcomes give 2*2*3 =12 possible outcome groupings or

scenarios (see Table 2).

40

Journal of Forecasting

Table 2.

Outcome

Scenario

Probability

Al

1

2

3

4

5

6

7

8

9

10

11

12

yi

yz

yi

y4

ys

yt

>,

ys

y9

>',o

yn

vi2

1

1

0

0

1

1

0

0

1

1

0

0

A2

0

0

1

0

1

1

1

1

0

1

1

1

0

C2

C3

0

0

0

0

0

0

0

0

0

0

0

0

1

1

1

1

0

0

0

0

0

1

0

1

0

1

1

0

0

1

1

0

0

Cl

B2

BI

1

1

1

1

0

1

+ ys + J6 H- ;'9 + yio = P ( A 1 ) , i.e., the sums of the probabilities for the scenarios comprising

outcome Al are added. Accordingly, the joint probability of Al and BI in this example is the

sum of probabilities of scenarios including both of these scenarios: yi + ys + y9^ P(A1 BI).

If our representation of marginal and joint probabilities pii) and pii'j) includes only a

subset of all possible scenarios (for example, all compatible scenarios), then we replace the

equal sign with a greater than or equal sign ( ^ ) . This results in the vector notations of

constraints (1) and (2) in the LP model.

Constraint (3): If N is the number of all possible scenarios, then S>'s=l

is=\,...,N).

However if we only are considering K scenarios, where K ^ N, then Zys < 1 (5 = 1,..., K).

Constraint (4): This constraint determines the difference between the preliminary and final joint

probabilities. When p*ii'j) < pii'j), then the difference is dij. When p*ii'j)>pii-j)

then

the difference is dij. When p*ii'j) = pii'j) then dij= dij = 0.

Constraint (5): To explain constraint (5) we shall use the example in Table 2. We find:

piAl) = p*iA\ B\) + p*iAl BI)

piAl) = p*iA\ -C\) + p*iAl - C2) + p*iA\'

C3)

piC3) = p*iC3'

*

BI)

* + p*iC3'

BI)

*i

The probability of each outcome must equal the sum of the joint probabilities for this outcome,

and every other outcome both occurring and non-occuring.

Constraints (6) and (7): Constraint (6) defines the generalized difference variable d as an upper

limit, i.e. maximum of all individual distance variables dij Andrf,^during the minimization.

Constraint (7) ensures that all variables must be hon-negative.

The linear program outputs the scenario probabilities ysis= I, ...,K), the final joint probabilities p*ii'j), the individual differences between preliminary and final joint probabilities du

and du, and their maximum d. Finally, the corrections to the joint probabilities (and thus the

41

compatibility values) are based on the attempt to bring the original estimates in line with the

laws of probability theory.

As a result of the LP model described above, we have obtained scenario probabilities which

fulfill our chosen objective function's demand for minimized difference between preliminary

and final joint probabilities. After determining this first optimal solution, we should follow up

with a post-optimality analysis. Here we will examine each scenario probability to determine the

range in which it could fluctuate without the final objective function value changing.

If there is no available standard procedure for post-optimality analysis (sensitivity analysis),

then the sensitivity range of the scenario probability Vs could be calculated by minimizing this

variable once and maximizing it once. With an additional constraint the objective function of

the first LP model can be set equal to OFl, where OFlmin is the minimal objective function

value of the first LP model:

Min v, then Max \\

subject to:

Constraints (l)-(7)

Constraint (8): S,,(/,7+c?,)) + 10,000-c^= OFl ^m,

s=\,...,K.

As an input value for the third stage, the cluster analysis, the simplest method is to take the

arithmetic mean of the upper and lower bound of each scenario probability.

Determination of a few main scenarios using cluster analysis

After completing stages 1 and 2 of our procedure we have many scenarios with, at best very low

starting probabilities. In strategic planning it is practical only to consider a small number of

major scenarios. Cluster analysis gives us the option to combine this multitude of scenarios into

a small number of main scenarios. Without going into the details of cluster analysis procedures

here (see Bohler, 1977; Martino and Chen, 1978; Steinhausen and Langer, 1977), we will only

address a few details important to our examination.

We turn to cluster analysis to be able to recognize important characteristics of the str^ucture

of the synthesis of a multitude of individual pieces of data (Steinhausen and Langer, 1977). To

do this we attempt to organize homogeneous groupings of scenarios where the groups are as

heterogeneous among themselves as possible. We therefore cannot make any general assertions

about the number of clusters (usually two to four), which is dependent on the structure of the

problem. The selection of a measure of distance which defines homogeneity and heterogeneity,

must be in accordance with the scaling of the factor outcomes (usually a nominal scale).

Sometimes a rescaling will be necessary. Note, that the basis for clustering is similarity defined

by the Euclidian distance between pairs of scenarios. Potential consequences of scenarios are

not taken into account. However, alternative clustering criteria seem possible.

The theoretical 'centre' of clusters calculated by cluster analysis algorithms can be viewed as

representing the possible major final states. A probability, consisting of the sum of the

probabilities of the scenarios belonging to the cluster is associated with each 'centre* These

centres do not usually correspond entirely to possible real scenarios. If, for example, a factor

'dominant political opinion' has the outcomes: 'liberal' with a value of 2, and 'conservative'

with a value of 3, then the center could formally be given the value 2.8. We can now follow one

of two procedures. One close-lying scenario can be defined as a representation of the centre.

Alternatively, a vague outcome for a factor could be an indicator of the range of variance of

this factor in the cluster. In many cases it may be important not to describe a major future state

42

Journal of Forecasting

too exactly because the method and the data may not support such precision. It is especially

important in this last phase, with its final description of the main scenarios, to encourage strong

interactions with management.

EXAMPLE

In the following example we consider three environmental subsystems relevant to a fictitious

problem: 'society', 'technology' and 'the economy* The subsystem 'society' is described by a

factor (SI) with three outcomes (S11,S12,S13) and three factors (S2,S3,S4), each with two

outcomes (HiS/1 and H2S/2 where / = 2,3,4). 'Technology' is represented by the factor (TI)

with two outcomes. The subsystem 'the economy' has two factors (El and E2) with two and

three outcomes respectively.

Table 3 describes all the data necessary to run through this new procedure:

(1) a list of all factor outcomes e, (/ = 1

16)

(2) the determined compatibility values ku for every 2 outcomes e, and ej (where A:y = 1,..., 5)

(3) the estimated probabilities pii) for the individual outcomes e,.

In this example there are 2' 3^ = 288 possible outcome combinations (scenarios). In the first

stage of the new procedure, all compatible scenarios (i.e. those without a value of 1) are

SI

S2

S3

S4

TI

El

E2

1 2

1 2

1 2

1 2

1 2

1 2 3

Outcomes

Factor

0.3

0.4

0.5

SI: Dominant

Political Opinion

0.6

0.4

1 2

Sll*;: socialist

S12: liberal

S13: conservative

on the Economy

and Society

S21: strong

S22: weak

5 1 3

1 5 3

0.6

0.4

S3: Consumer

Spending

S31: strong

S32: weak

2

4

3

3

ut Ul

Pii)

0.7

0.3

S4: Environmental

Protection

S41: strong

S42: weak

5

1

3

3

2 5

4 2

Ul Ul

Ul Ul

0.2

0.8

El: Economic

Growth

Ell: rising

E12: stagnating

2 4

4 2

2 4 5 1 2 4 5 1 X

3 3 2 4 3 3 3 3 1

0.3

0.5

0.2

E2: Unemployment

E21: rising

E22: no change

E23: falling

2 .

3

4

Ul Ul

1 4

4 2

5 2 4

2 5 2

Ul Ul

Ul Ul

2 2 4 2 4 2

4 3 3 3 3 4

3 4 2 4 2 3

Compatibility Ratings

1 Ul Ul Ul

1 Ul Ul Ul

Innovation

T12: low

to. bo

ro ro

2

5

p p

4

2

Ul Ul

Ul Ul

1**X

1 1

2 4 1 5 X

3 3 3 3 1 X

4 2 5 1 1 1 X

43

determined using the first part of the computer program KONMACA (von Nitzsch et al., 1985).

In our example there are 46 scenarios. To simplify our investigation, we will examine only some

of these compatible scenarios. The following criteria will guide our selection: (a) the number of

2 ratings (denoted as 'mistakes* in Table 4) should be less than 4; or (b) the scenario weighting

(defined as the average compatibility rating of the scenario) should be greater than or equal to

3.286.

Table 4 shows the result of this selection process: the block of columns marked 'outcomes'

shows which outcomes will be accepted for any given scenario (1 to 32) for each factor (SI

through E2).

Every compatible scenario can be represented as an overview table using the KONMACA

system. For example take scenario 4^ the scenario with the highest weighting. Table 5 exhibits

the estimated compatibility values for the individual outcome pairs and the factor outcomes for

scenario 4. It gives, among other things, a simple localization of Table 4's 2 ratings (i.e.

mistakes).

In the second stage of this procedure we calculate the probabilities of the scenarios chosen in

the first stage. Here we use the second part of the KONMACA program. It consists of a matrix

generator which, based on the compatibility values and marginal probabilities of the individual

outcomes, produces the input data set according to the LP model described above. The LP for

the example contains 549 constraints and 328 + K variables. K is the number of scenario

probabilities considered, where K < 288. Since we selected A^= 32 scenarios in the first stage,

the solution LP now contains 360 variables. Based on the solution of this LP, upper and lower

bounds for all scenario probabilities and when appropriate, the arithmetic mean, are

calculated. (Table 6 shows the mean scenario probabilities ys (as a percentage) for the selected

scenarios, where s=\, ...,32.)

The cluster analysis is performed using the PKM-program from the BMDP package (o. V.,

1981; von Nitzsch et al., 1985). We calculated solutions for two sets of trials with two, three.

Table 4. Selected compatible scenarios

Outcomes

Outcomes

Scenario

S S S ST E E

1 2 3 4 11 2

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

1

1

2

2

2

2

2

2

2

2

3

3

3

3

3

3

12 1 1 2

12 12 2

2 12 11

2 12 11

2 12 12

2 2 112

2 2 12 2

2 2 2 12

2 2 2 2 2

2 2 2 2 2

1 1 2 11

1 1 2 11

112 12

112 2 2

12 1 1 2

12 12 2

2

2

2

3

2

2

2

2

1

2

2

3

2

2

2

2

'Mistakes'

Weight

Scenario

2

1

0

1

2

2

3

3

3

3

1

1

1

2

3

3

3.381

3.524

3.667

3.810

3.238

3.286

3.190

3.095

3.333

3.095

3.524

3.714

3.286

3.143

3.095

3.143

17

18

19

20

21

22

23

24

25

26

27

28

29

30

31

32

For example: Scenario 4 = (S12, S22, S3i, S42, Til, EH, E23)

S S S ST E E

1 2 3 4 11 2

'Mistakes'

Weight

12 2 12

12 2 2 2

2 12 11

2 12 11

2 12 12

2 12 2 2

2 2 112

2 2 12 2

2 2 2 12

2 2 2 2 2

2 2 2 2 2

12 1 1 2

12 12 2

2 12 12

2 2 112

2 2 12 2

3

2

0

1

1

2

3

3

3

3

2

6

4

4

4

4

3.048

3.190

3.619

3.714

3.286

3.143

3.095

3.143

3.048

3.333

3.190

3.286

3.524

3.286

3.333

3.333

3

3

3

3

3

3

3

3

3

3

3

1

1

2

2

2

2

2

2

3

2

2

2

2

2

1

2

1

1

1

1

1

44

Journal of Forecasting

Table 5. Scenario 4

Gov't Influences

Consumer Spending

Environmental Protection

Rate of Techn. Innovation

Economic Growth

Unemployment

liberal

minimal

strong

weak

high

higher

falling

S12

S22*

S31

S42

Til

Ell

E23

S12

S21

S31

S41

Til

Ell

5**

3

3

5

4

3

3

3

3

4

2

4

5

5

4

3

4

3

5

4

E23

Table 6.

ys

ys

ys

ys

1

2

3

4

5

6

7

8

7.50

5.00

3.75

2.50

3.75

10.00

0.00

3.75

9

10

11

12

13

14

15

16

0.00

0.00

3.75

3.75

3.75

2.50

3.75

3.75

17

18

19

20

21

22

23

24

3.75

3.75

3.75

2.50

3.75

2.50

3.75

3.75

25

26

27

28

29

30

31

32

3.75

3.75

3.75

3.75

3.75

3.75

7.50

0.00

four and five clusters each. In one set of trials, three cluster centres were predefined. The other

set had no predefined cluster centres. Using a predefined centre is one method of incorporating

possible knowledge of experts or managers regarding the structure of the problem as a starting

solution for cluster analysis. Generally, of course, increasing the number of clusters increases

the homogeneity within a cluster but thus reduces the heterogeneity between clusters. With the

data given, it seems logical to construct three clusters, as four or five would not produce any

new (in terms of heterogeneity) main scenarios. Since the results with and without predefined

centres do not strongly differ, those representations with predefined centres will be used.

The appointed starting cluster contains the highly contrasting scenarios 3( = 22 1 2 1 1 1),

27( = 3 2 2 2 2 2 2) and 28(= 1 12 1 12 1). We then alter the scaling of the factors with two

outcomes (S2, S3, S4, Tl, El) and assign the value 3 to the second outcome. In this way the

difference between the extreme outcomes is the same for each factor. Table 7 shows the results

of a cluster analysis, three clusters with the distance of the scenarios to the centre.

We should emphasize the calculated cluster probabilities. If we assume equal probabilities for

each scenario, then cluster 2 occurs with approximately 47% probability (i.e. p-incorrect) and

cluster 3 occurs with only about 22% probability. However, when talcing into account the

results from stage 2 we see that cluster 3 (p = 37%) is actually more probable than cluster 2

(p = 33%). Table 8 displays the centres for the first cluster for our example.

The maximums and minimums define the ranges of the factor outcomes.

Table 7.

Cluster I

Scenario

Distance

3

4

5

11

12

13

19

20

21

30

.18

.41

1.48

.67

[.84

1.89

.09

.34

.41

1.89

Cluster 2

Scenario

Distance

7

8

9

10

14

16

17

18

22

23

24

25

26

27

32

p-incorrect

p-incorrect

P

31.25

30.7

46.875

Probabilities in percentages

Table 8.

Cluster 3

Scenario

Distance

1.70

1.85

1.47

1.25

2.45

2.10

2.22

1.76

2.04

2.10

1.60

1.76

1.35

1.11

1.87

1

2

6

15

28

29

31

1.07

1.69

1.65

1.69

1.14

1.73

1.69

P

32.8

p-incorrect

21.875

P

36.5

Factor

1

2

3

4

5

6

7

45

SI POL.O

S 2 - INFLU

S3 - CONSU

S4 - ENVIR

Tl -- INNOV

El - ECON

E 2 -- UNEMP

Minimum

Centre

Maximum

2.0000

1.0000

1.0000

3.0000

1.0000

1.0000

1.0000

2.6000

2.4000

1.0000

3.0000

1.0000

1.8000

2.2000

3.0000

3.0000

1.0000

3.0000

1.0000

3.0000

3.0000

CONCLUDING REMARKS

In this paper we proposed a new method for scenario analysis. Starting with relatively simple

data obtained from managefs, this procedure determines possible alternate main future states

(scenarios) and their probabilities. The scenarios developed thus serve as starting points for

further investigations in the strategic planning process.

A part of this methodology (stage 1) was successfully tested in a workshop attended by

students and faculty. Stages 1 and 3 of the new procedure were validated as part of their first

practical application in the strategic planning process at a large German company. We were

encouraged by the reactions to the use of a formal methodology as part of a process generally

based on experience and intuition.

46

Journal of Forecasting

ACKNOWLEDGEMENTS

We gratefully acknowledge the help of Mr. Rudiger von Nitzsch for his assistance with

computer-related aspects of this research. We would also like to thank Michael Bieber at the

Wharton School for translating this paper from the original German.

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Authors' biographies

Jutta Brauers is working in the planning department of a large German company. She holds a Master in

Business (Dipl.-Kfm.) from Aachen University. During her study she worked as a research assistant at the

School of Management at Aachen. Currently she is developing a computer-based information system.

Martin Weber is an Assistant Professor (Wissenschaftlicher Mitarbeiter), School of Management, Aachen

University. He received a Master in Mathematics (Dipl.-Math.) and Business (Dipl.-Wirtschaftsmath.)

and a Ph.D. in Business (Dr.rer.pol.) from Aachen University. He has held visting appointments at

Helsinki School of Economics, Graduate School of Management, UCLA and the Wharton School,

University of Pennsylvania. His research interests are in planning, decision making and finance.

Authors' addresses

Jutta Brauers, Kronenstr 2, 4000 Dusseldorf 1, West Germany

Martin Weber, Lehr-und Forschungsgebiet Allgemeine Betriebswirtschaftslehre,

Templergraben 64, 5100 Aachen, West Germany.

Please address all correspondence to Martin Weber at the above address.

RWTH Aachen,

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