September 24: An overview of scenario analysis

The purpose of forecasting is to help you plan for the future.

Suggest a topic for a future fact.

Source: CFI
Published: February 2020
Reader submission by Mark Gaines

An overview of scenario analysis

The purpose of forecasting is to help you plan for the future. One method of forecasting uses three scenarios: 

  1. Worst-case scenario: Start by calculating the expected scenario. Reduce the expected scenario results by 20-30%*.

  2. Expected scenario: Base-case assuming operations perform normally. Use your judgment to make realistic assumptions.

  3. Best-case scenario: Start with the expected scenario and assume that everything goes perfectly. Improve the expected scenario results by 20-30%*.

Real-life examples from Amazon:

  • Amazon Kindle sold out in 5.5 hours when first released in November 2007. The best-case scenario was massively exceeded and the company had to quickly manufacture more units to meet the customer demand!

  • Amazon Fire Phone was a flop causing Amazon to report a $170 million write off just 5 months after launch in October 2014. Sales were drastically below the worst-case scenario.

*Note: 20-30% is a helpful rule-of-thumb, but people will use different ranges. There is no “right” answer.

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