The following Insights post is contributed by Tom Hartley – Market Economics and Intelligence Strategist – Former AVP at McKesson and expert JPK Group Presenter.
I recently worked on a project where I became re-acquainted with Probabilistic Modeling (Monte Carlo Simulation) and how it can be used to reflect risks that are inherent in business. Many organizations don’t adequately plan to account for variance and risk in their business. This risk can be competitive risks resulting in aggressive price pressure. It can be market risk around adoption of solutions or services that are just launched. Regulatory risk of new legislation that impacts your customers or customers’ customers. Technology risk; execution risk; organizational risk… the list goes on and on.
So a business planning process that uses static variables in the model seems woefully inadequate if you want to understand the dynamics of how these potential risks can impact your business. Often scenario analysis is done where one variable (usually sales or unit costs) is changed to reflect a pessimistic case… usually changed in a vacuum with little consideration or thought of what might happen to the whole system if one variable changes. This is not very realistic either.
What probabilistic modeling does is allow planners to incorporate a potential range of possible variables and how they are correlated to one another. These models, run over thousands of times, develop a distribution of potential outcomes to identify which variables have the largest impact on the outcomes – both positively and negatively. Variables that move together or counter to one another are correlated positively or negatively. Discrete events that have a low likelihood of occurring can be accounted for… and the resulting impact to the business can be reflected even though the occurrence is usually quite remote. If done properly, companies can gain a good perspective on what are the key things to focus on and the range of potential business results that can be expected.
Gone are the days where you can plan your business based on last year’s, or the last five years’, results. Businesses need to reflect potential risks in their business planning to understand what aspects of their businesses to focus on to best ensure success.
Tom Hartley has over 20 years’ experience developing market strategies in high growth and emerging industries. Most recently at McKesson Health Solutions, Tom led the Market Economics and Intelligence Team. This team led market analysis projects and “Voice of the Customer” programs that informed long range strategic planning and new product business cases. Also while at McKesson Health Solutions, Tom developed pricing strategies across the group’s portfolio of solutions. Prior to McKesson Health Solutions, Tom spent 12 years leading consulting engagements with Deloitte and Oliver Wyman, as well as other industry leading boutiques. As a consultant, Tom helped companies develop market strategies to thrive in the (then emerging) Internet economy and led strategic pricing engagements in industries as varied as software, silicon wafers and paper. Tom holds a Bachelor of Science degree in Business Management from San Diego State University and a MBA in Marketing, Finance and Information Science from Indiana University.