Sensitivity Analysis:

Charting the Unknown

By Greg Silverman, June 22, 2020

Why do we fear the unknown? Is it because of the anxiety the thought of making the wrong decision induces or merely the fact that unknown outcomes imply situations out of our control? Entrepreneurs chalked up the fear of the unknown to the instinct humans have for self-preservation. Uncertainty most certainly means change, and the trepidation about losing control and being unable to manage circumstances holds people back.

Businesses operate in a similar fashion. After all, they are led by humans balancing their strategic decision-making with their own fears of the future. What many business leaders don’t realize is that the unknown is full of opportunities if they wield the correct tools to overcome their worries. A sensitivity analysis test helps businesses achieve accurate risk modeling to chart the unknown, so even in the face of uncertainty, they are able to take fast and accurate actions to achieve their goals.

 

What is business risk modeling?

 

Businesses are always facing risks from external factors seemingly outside of their control. Just glimpse at the ever-changing political or economic landscape, or even how a natural disaster has the ability to disrupt business operations. The Council on Library and Information (CLI) explained that while external risks can neither be eliminated nor predicted, identifying the threats that exist in the environment in which the business operates is the first step to mitigate their potential impact. 

In times of uncertainty, business leaders may instinctively want to defend their organization by cutting spending and reducing investments. On the other hand, they may continue to operate like business as usual in an effort to power through an unexpected event without needing to make changes to their internal processes. However, both of these reactions are counterproductive to the business’s growth. Only by analyzing each risk, its potential for occurring and its consequences, are businesses empowered to develop strategies to respond to each situation while still progressing organizational goals.

Ultimately, business risk modeling is a balancing act between how much risk is acceptable and how to benefit the business by making strategic decisions. With risks constantly changing and the consequences of said threats becoming more severe and complex, businesses need a way to help them model sensitivity.

 

What is sensitivity analysis: Taking control of the unknown

 

The concept of sensitivity analysis, also called what-if analysis, takes a range of input factors that drive performance to determine the spread and volatility of the range of outcomes (mathematically referred to as sensitivity coefficients). This analysis is more than simply running a scenario to see what could happen, and it actually helps business users make decisions to obtain certain outcomes. According to Statistics How To, this analysis focuses on what happens to the dependent variable when parameters change. 

 

What does a sensitivity analysis show?

 

While this approach is typically applied to areas such as finances and economics, organizations should also use sensitivity analysis to ask questions about their marketing strategy, product positioning, and other more abstract business decisions. Sensitivity analysis statistics captured in simulation is used to explain a full system, so it’s best for businesses that want a comprehensive understanding of their actions across departments and how, together, they influence outcomes. 

Business users pull different levers, also known as variables, in the simulation to see how their hypothetical actions would affect their goal. With a granular approach to what affects the outcome, users determine which variables are the most sensitive - and therefore have the most value - to create change. For instance, if a business leader needed to adjust their budget, they could determine how reducing or increasing marketing spending could impact growth. They may find that decreasing another variable has less impact on their goal to achieve more sales than increasing marketing spend and would, therefore, understand that marketing budget has a greater effect on the model and use this insight to make their decision. 

With the results of these scenarios and actions, users see the probability distribution that these events will occur and are able to define a plan of action moving away from randomness and uncertainty to a response that’s in their control.

 

Producing the best plan of action

 

What-if analyses are especially important during times of uncertainty as they are used to answer complex business questions that static models cannot adequately forecast. Perhaps most importantly, sensitivity analyses allows business users to continuously learn about how their actions affect the business. In traditional models, someone may be under the impression a parameter value is more sensitive than it truly is or overlook another variable, leading to unmeasured confounding variables arising. An agile and user-friendly what-if solution lets users test all possible levers, so they do not miss an emergence opportunity to capitalize on.

Again, while even global sensitivity analysis does not eliminate uncertainty for businesses, it does allow organizations to plan for different circumstances and intervene with their strategy to continue to move it toward its ultimate goal. With the confidence that they understand each variable and how it affects outcomes, business decision-makers mitigate risk even in the face of uncertainty by choosing the most effective strategy. 

Rather than try to determine what will happen next, sensitivity analysis techniques empowers businesses to figure out how to make a course of action occur in their favor. The market is a complex system made of many independent moving parts. Sensitivity analysis breaks these variables down within a unified simulated market to determine how the parts affect the whole that the business is trying to appeal to. Uncertainty is a constant, so it’s essential for every business to understand the environment in which they operate along with how their decisions affect consumers.

Concentric Market® is the singular platform from where your team is able to run what-if scenarios to make strategic decisions. With a tried and tested model based on your business environment, you harness the power of forecasting to determine which decision is likely to deliver the best results. Contact us today to learn more. 

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