Assumption-based planning: Difference between revisions

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'''Assumption based planning''' in [[project management]] 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 plan]]s, test these assumptions and think of hedging actions and what-if scenarios.

'''Assumption-based planning''' in [[project management]] 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 plan]]s, to test these assumptions, and to accommodate unexpected outcomes.

== Overview ==

Conventional business planning methods operateworks on the premiseexpectation that managers can extrapolate future results from a well-understood base of information from the past. Howeverexperience, but for new businesses and projects this way of planning oftenis doesoften not complypossible. MostExperience ofmay thebe timelacking thereor isextrapolating nofrom past-knowledge andexperience ifmay there’sbe anymisleading.<ref>Christensen, pastC., knowledgeKaufman, availableS., predicting& theShih, futureW. out2008. ofInnovation itkillers: ishow nearlyfinancial impossibletools destroy your capacity to do new things. Harvard Business Review, 86(1): 98-105, 137.</ref>

Assumption-based planning methods include:

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.

* Critical assumption planning (CAP) by D. Dunham & Co.<ref>{{Cite journal |last=Sykes |first=Hollister B. |last2=Dunham |first2=David |date=1995-11-01 |title=Critical assumption planning: A practical tool for managing business development risk |url=https://www.sciencedirect.com/science/article/pii/088390269500085M |journal=Journal of Business Venturing |volume=10 |issue=6 |pages=413–424 |doi=10.1016/0883-9026(95)00085-M |issn=0883-9026|url-access=subscription }}</ref>

* Assumption-based planning by [[RAND]] : raises the visibility of make-or-break uncertainties common to new ventures by forcing managers to admit what they don't know.

* Discovery-Driven Planning by [[Rita Gunther McGrath]] and Ian C. MacMillan.<ref>McGrath, R. G. & MacMillan, I. C. 1995. Discovery Driven Planning. Harvard Business Review, 73(4): 44-54.</ref><ref>McGrath, R. G. & MacMillan, I. C. 2009. Discovery Driven Growth: A Breakthrough Process to Reduce Risk and Seize Opportunity. Boston: Harvard Business Publishing</ref>

Assumption-based planning methodologies provided the foundation for other planning frameworks and tools such as [[Robust decision-making]].

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.

== Position in business planning process ==

There are a couple of different assumption based planning methods available, among others:

Most business planning methods or books about "how to write a business plan" indicate that you should write down your financial assumptions at the end of your plan, but assumption-based planning encourages managers to actively plan and monitor the validation of these assumptions.

* [[Critical assumption planning]] (CAP) by D. Dunham & Co : Aims to help managers and entrepreneurs to maximize business development learning at least cost by means of challenging and testing assumptions.

* Assumption-based planning by [[RAND]] : Aims 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.

* Discovery-Driven Planning by [[McGrath]] : aims 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.

The identification of assumptions may lead to a change in the business plan, so advocates of assumption-based planning argue that it should be at the core of business planning.

== Assumption based planning topics ==

=== Position in 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:

==Types of assumption==

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 number of people that could buy their glow-in-the-dark shampoo and the number of bottles they hope to sell to each customer.

[[RAND]] defines an assumption as "an assertion about some characteristic of the future that underlies the current operations or plans of an organization." There are several types of assumption. Include implicit and explicit assumptions, and primary and secondary assumptions, an important aspect of critical assumption planning. The two classifications are not mutually exclusive; an assumption can be both explicit and primary.

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.

=== Implicit and explicit assumptions ===

Explicit assumptions are fully revealed without vagueness, implication, or ambiguity—though in a plan, they often rely on [[implicit assumption]]s. Implicit assumptions are not expressed and may go undetected. If implicit assumptions are wrong, this can damage projects.

Assumptions according to Wikipedia are “[[proposition]]s 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. 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. 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.

{|

|+ CalloutExamples 1of Someimplicit Dangerous Implicit Assumptionsassumptions:<ref>McGrath, R. G. and I. C. MacMillan (1995). ''Discovery-Driven Planning''. Harvard Business Review.</ref>

|-

| style="background-color: #CCC; border: 2px solid black" |

# Customers will buy our product because we think it’sit's a good product.

# Customers will buy our product because it’sit's technically superior.

# Customers will agree with our perception that the product is “great”great.

# The product will sell itself

# Distributors are desperate to stock and service the product.

# We can develop the product on time and on budget.

# Competitors will respond rationally.

# We will be able to hold down prices while gaining share rapidly.

# We will have no trouble attracting the right staff.

# Customers will run no risk in buying from us instead of continuing to buy from their past suppliers.

|-

|}

== Process ==

=== Primary and derivative assumptions ===

[[File:ABP_process.png|thumb|320px|Assumption-based planning (ABP). 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.<ref>The modelling method in general is a result from a method engineering approach as proposed by the [[University of Utrecht]] in its "Method Engineering Encyclopedia"</ref>]]

Besides the distinction between implicit and explicit assumption the Crital Assumption Planning method distinguishes two other types of assumptions: primary and derivative assumptions.

The steps of assumption-based planning (ABP) are:

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.

* Identify assumptions: Collect all assumptions implicit, explicit, primary and derivative, out of the (business) plan.

* Determine criticality: quantify assumptions as much as possible in order to determine which assumptions have the greatest (financial) impact.

* 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 tests: Every critical assumption must 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 assumptions: When an assumption is tested this results in a test outcome, which proves the assumption right or wrong.

* Reassess 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: assumptions must be re-tested regularly if not constantly. There should be a retest schedule for every critical assumption.

* Create or update the assumption plan: The assumption plan holds all data gathered during the ABP process.

==Critical assumption planning==

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 number 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.

''Critical assumption planning'' (CAP) is a service mark of D. Dunham & Co. It helps managers and entrepreneurs maximize business development learning at least cost. The continuous process consists of six steps: Knowledge Base Assessment, Critical Assumption Planning, Test Program Design, Funding Request, Test Implementation and Venture Reassessment.<ref>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.</ref><ref>Block, Zenas and Ian C. Macmillan (1985). [http://hbr.org/1985/09/milestones-for-successful-venture-planning/ar/1 "Milestones for Successful Venture Planning."] "Harvard Business Review" September 1985.</ref>

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.

CAP is built on the foundation of the work of Block (1989) who showed that assumptions can stand in the way of perceiving current business realities. The identification and assessment of assumptions solves this problem and forms the foundation for managing new business ventures.

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.

CAP involves six steps, combined in a "Learning Loop". Once all six steps are completed, a milestone is reached and the loop starts over again. The loop is constantly repeated as the business is developing.

{|

[[image:Cap-process.png|frame|none|The Critical Assumption Planning Process]]

|+ Callout 2 - Deriving assumptions out of an explicit statement

|-

| style="background-color: #CCC; border: 2px solid black" |

* “If we are later than 12 months, we will start losing opportunities”. If so…

** The product will be available

** The competitors have the capability to close the deals in 12 months

** There must be an opportunity for us to lose, if so…

*** A customer is identified

*** The customer will feel a need to buy

|-

|}

===Knowledge-base assessment===

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.

This step takes "a comprehensive analysis of what is known and unknown about the competition, market and technology" (Sykes 1995). In this step the entrepreneur oversees his plans and the first assumptions are exposed. Important parts of the [[business plan]] to check are the definition of the business concept and an assessment of the competition.

===Critical assumption identification===

== The Assumption Based Planning Process ==

During this step the assumptions are identified and there is a determination of criticality. The hardest part of CAP is to identify the assumptions that are not written down.

[[Image:ABP process.gif|thumb|320px|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.

To determine the criticality of the assumptions, they must be quantified. This makes it possible to put the financial results in a [[spreadsheet]] and link them. These financial impacts change for various assumptions.

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.<ref>The modelling method in general is a result from a method engineering approach as proposed by the [[University of Utrecht]] in it's "Method Engineering Encyclopedia"</ref> The steps are:

CAP measures the criticality of an assumption as a change in the [[net present value]] of a venture (NPV). To determine criticality each assumption is assigned a range of uncertainty: base case, best and worst case. Then, assumption for assumption, while keeping the other assumptions at [[ceteris paribus|base case]], the NPV changes for each assumption in the worst- and best-case scenarios are checked.

* 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%”.

The NPV analysis proves the company with information about the criticality of an assumption. Two signals strongly indicate a critical assumption: a big difference in NPV between the best and worst-case scenarios, or a huge loss of NPV in the worst-case scenario

* 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 program design===

* Test Assumption : Then an assumption is tested this results in a test outcome, which proves the assumption right or wrong.

The assumptions must be tested. Sometimes good market research is enough,

* 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.

other times a working prototype must be developed. The testing order for assumptions is critical in terms of testing cost. A major focus of the CAP method is to maximize the learning per unit expenditure on testing.

* 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.

To determine the best testing option, the test Effectiveness ratio (e)

is calculated for one or more assumptions based on the estimated Costs (C), Time spend on testing (T) and the estimated reduction (R) between the NPV values of the assumptions (P as a percentage of the NPV range). Using these parameters, the effectiveness ratio (e) is calculated:

<math>

e = \frac{\sum (PR)}{CT}

</math>

<!--

e = SUM(PR) / (CT)

-->

Once the best testing option is chosen from the different test effectiveness values, the organisation can finish the planning of the test.

===Funding request===

When the test program design is ready and the costs are clear, resources must be allocated to the test program. In most companies or start-ups clearance from senior managers or [[venture capitalists]] is needed to conduct the tests.

===Test implementation===

In this step the actual testing of the assumptions takes place.

===Venture reassessment===

When the results of one or more tests are known, it might be that resources must be re-allocated and business plans updated.

== References ==

{{reflist}}

==External links==

{{verify}}

*[http://dgital.link/critical-assumption-planning Australian CAP Case Study]

== Further reading ==

* Dewar, J.A., Builder C.H., et al. (1993) "[http://www.rand.org/pubs/monograph_reports/MR114/ Assumption-Based Planning: A Planning Tool for Very Uncertain Times]", Santa Monica, [[RAND]].

* Dewar, J.A. (2002) "Assumption-Based Planning: A Tool for Reducing Avoidable surprises", Cambridge UK, Cambridge Press.

* 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.

[[Category:ProjectSchedule (project management)]]