Assumption based planning
From Wikipedia, the free encyclopedia
Assumption based planning is a post-planning method that helps companies to deal with uncertainty. It is used to identify the most important assumptions in a company’s business plans, test these assumptions and think of hedging actions and what-if scenarios.
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[edit] Assumption Based Planning in General
Conventional business planning methods operate on the premise that managers can extrapolate future results from a well-understood base of information from the past. However, for new businesses and projects this way of planning often does not comply. Most of the time there is no past-knowledge and if there’s any past knowledge available, predicting the future out of it is nearly impossible.
The managers’ solution to this problem is to make assumptions; their best try to predict the future. Some of the assumptions made during the planning process are very likely to come true; the outcome of others is very much uncertain, though not less important. Assumption based planning is about the identification and testing of the assumptions made in a business plan, the formulation of “hedging actions” and the construction of “what-if” scenario’s.
In short, this means that uncertainties are identified, a test is designed to make things clear and while waiting for the uncertainty to become certain you think of what (not) to do if the original prediction proves to be false. The point of assumption based planning is therefore not to demand the highest degree of accuracy for all assumptions made in a business plan, but to build a reasonable model to assess the order and magnitude of the challenges a new project or company will face.
There are a couple of different assumption based planning methods available, among others:
- Critical assumption planning (CAP) by D. Dunham & Co.
- Assumption-based planning by RAND and
- Discovery-Driven Planning by McGrath
Each of these methods has a different goal, but they share their intent to prepare managers for surprises and improve the robustness and adaptability of business plans. Table 1 summarizes the goals of the assumption based planning methods listed above.
| Method | Goal |
|---|---|
| Critical assumption planning by D. Dunham & Co. | To help managers and entrepreneurs to maximize business development learning at least cost by means of challenging and testing assumptions. |
| Discovery-driven planning by McGrath and MacMillan | Raising the visibility of the make-or-break uncertainties common to new ventures at the lowest possible cost by means of forcing managers to articulate what they don’t know. |
| Assumption-based planning by RAND | To identify the critical assumptions underlying an organization’s thinking and operations, and then to understand which of those assumptions may become vulnerable and how. |
[edit] The position of ABP in the Business Planning process
Most business planning methods or books about “how to write a business plan” do indicate that you have to write down your financial assumptions at the end of your plan. Few works however actually support you to actively plan and monitor the validation of these assumptions. Assumption planning does just that. Consider the following situation:
Paul and Harvey, two experienced entrepreneurs, are planning to start a new company, which is going to sell a glow-in-the-dark shampoo. During the business planning process they give a description of the potential customer base and the size of the market for their product. They write down the amount of people that could buy their glow-in-the-dark shampoo and the amount of bottles they hope to sell to each customer.
The claims about the market made by Paul and Harvey are assumptions, based on a combination of gut feeling, market research and maybe some information gathered out of past experiences of both entrepreneurs. In order to avoid surprises Paul and Harvey take assumption based planning to hand and start asking themselves the following questions:
- How are we going to prove that there exists a customer base of more than 2 million people? And what is a clear sign that there actually are more than 2 million people, to whom we could sell our shampoo?
- What proves that the average customer will use a bottle of glow-in-dark shampoo per 3 months? How are we going to test that? What if the test proves us wrong?
- What are we going to do if we’re not certain about the size of the market by the end of September next year?
- We assume that there the product is not very sensitive to the consumer price, how can we show that we’re right?
Sometimes the mere identification of assumptions immediately leads to a change in the business plan. It is for that reason that ABP should be strongly interwoven into the whole business planning process.
[edit] Implicit and Explicit Assumptions
Assumptions according to Wikipedia are “propositions that are assumed, i.e., treated within the context of a discussion as if it were known to be true or false”. But although the Wikipedia definition of an assumption is correct, a better definition of assumptions in the context of business planning and ABP is given by RAND.
“An assumption is an assertion about some characteristic of the future that underlies the current operations or plans of an organization”
There are multiple types of assumptions. The most known derivation is between implicit and explicit assumptions. Another classification used in ABP is the derivation between primary and secondary assumptions. This latter categorization is discussed in the Critical assumption planning Wiki. The two classifications are not mutually exclusive; this means that an assumption can be both an explicit and a primary assumption, while another assumption can be implicitly derived.
Explicit assumptions are assumptions of which the intention that is fully revealed or expressed without vagueness, implication or ambiguity. (Based on the m-w.com definition of explicit). However, as you can read in the next section “Primary and Derivate Assumptions”, explicit statements in a plan often have underlying (implicit) assumptions. Explicit assumptions are often not hard to find, since they are explicitly stated in the business plan. Examples of parts in the business plan full of explicit assumptions are the financial forecast and the business system and organization.
Implicit assumptions are assumptions that are capable of being understood from something else though they are not expressed. (Based on the m-w.com definition of implicit). The problem is that some important implicit assumptions in a plan go undetected. And if no precautions are taken for a scenario where implicit assumptions prove to be wrong, this might lead to unpleasant surprises. Callout 1 lists ten dangerous implicit assumptions often made in business plans. It is important to identify both the implicit and explicit assumptions made in plan.
List copied from McGrath (1995) |
[edit] Primary and Derivative Assumptions
Besides the distinction between implicit and explicit assumption the Crital Assumption Planning method distinguishes two other types of assumptions: primary and derivative assumptions.
Primary assumptions are assumptions about whom the customer is, what he or she wants, how dense the customer population is, what they need and what the customer sees as the alternatives to your product. The primary assumptions define the foundation of a company.
Derivative assumptions are derived from the primary assumptions. Take for example a sales forecast. The numbers in the forecast are based on assumptions about customer demand, the amount of clients a sales person can visit in a week, the availability of the product and so on. Other examples of derivative assumptions are: the revenue forecasts, cash flow outlook and the return on investment.
The hypothesis in CAP is that knowing your primary assumptions will help you to better test your assumptions. CAP furthermore states that lots of strong statements stated in a business plan can be split up into primary and derivative assumptions; see callout 2 for an example.
By searching for the primary roots of the derivative assumptions or statements, you can identify the critical issues of a plan more rationally and design a sound test plan to prepare yourself for the unexpected.
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Once you have identified your derivative and primary assumptions as well as your implicit and explicit assumptions you can start quantifying them. It might sometimes be hard, but in order to determine the criticality of the assumptions you need a way of measuring the financial impact of failing or proving an assumption. Take for example the statement in callout 2 – “If we are later than 12 months, we will lose the opportunity”. You can probably restate this statement, based on the underlying assumptions to “For each month delay in product availability, beyond the 12th month, we will lose a market share of 3%”. This way you can calculate the financial impact of changes in the assumptions and start determining the criticality of the assumptions made.
[edit] The Assumption Based Planning Process
In order to provide a general overview of assumption based planning process a simplified process-data diagram is presented. This diagram is based on the “common” aspects of the Critical Assumption Planning, Assumption-based planning by RAND and Discovery-Driven planning methods. It is advisable to check out the separate methods for a more detailed description of the ABP process.
The "blue" part of the figure depicts the process steps of a general assumption based planning method, the "white" part identifies the separate deliverables. Every step is described in the assumption based planning process list displayed below the picture. The modelling method in general is a result from a method engineering approach as proposed by the University of Utrecht in the Method Engineering Encyclopedia
===Identify Assumptions=== Collect all assumptions implicit, explicit, primary and derivative, out of the (business) plan. ===Determine Criticality=== Try to quantify the assumptions as much as possible in order to determine which assumptions have the greatest (financial) impact. You can for example restate the statement “If we are later than 12 months, we will lose the opportunity” to “For each month delay in product availability, beyond the 12th month, we will lose a market share of 3%”. ===Design Tests=== Design a test for every critical assumption. In a test design you state how to test the assumption and what proves the assumption wrong or right. ===Schedule Test=== Every critical assumption needs to be tested, but not all assumptions can be tested in the present. So future assumptions tests are scheduled in a test schedule. Some possible reasons to schedule a test in the future are a lack of information in the present or a dependency on the test outcomes of other tests. ===Test Assumption=== When an assumption is tested this results in a test outcome, which proves the assumption right or wrong. ===Reassess Venture Plan=== Based on the test outcomes and the test schedule one might decide to reassess the venture plan and update the business plan with the new insights gathered in the ABP process. ===Plan Re-testing of Assumptions=== The assumptions need to be re-tested regularly if not constantly. There should be a retest schedule of every critical assumption. ===Create or update the Assumption Plan === The assumption plan holds all data gathered during the ABP process.
[edit] References
McGrath, R. G. and I. C. MacMillan (1995). Discovery-Driven Planning. Harvard Business Review.
Sykes, H. B. and D. Dunham (1995). "Critical assumption planning: A practical tool for managing business development risk." Journal of Business Venturing 10(6): 413-424.
Dewar, J.A., Builder C.H., et al. (1993) "Assumption-Based Planning: A Planning Tool for Very Uncertain Times", Santa Monica, RAND. Also available as a free download from http://www.rand.org/pubs/monograph_reports/MR114/ (Link checked April 13, 2006)
Dewar, J.A. (2002) "Assumption-Based Planning: A Tool for Reducing Avoidable surprises", Cambridge UK, Cambridge Press.
