Scenario analysis has become a popular tool to build resilience and ensure business readiness. In this blog, we explain what scenario analyses are, why they are important for companies and investors, and how some food retailers and manufacturers have begun using scenario analysis.
What is a scenario analysis?
Hypothesising about future scenarios to understand the potential impacts and plan accordingly is key for business longevity. According to the Task Force on Climate-Related Financial Disclosures (TCFD), scenario analysis enables companies to develop strategies that are adaptable and resilient to numerous climate-related risks and opportunities. By conducting such an analysis and incorporating the findings into its long-term business strategy, a company can mitigate these risks and limit future exposure.
Scenario analysis should be plausible, distinctive, consistent, relevant, and challenging. Additionally, some key elements need to be considered:
Climate scenarios. It is important to include more than one scenario. The chosen scenarios should reflect both optimistic and pessimistic future states of the world (see below for more detail).
Risks and opportunities. Especially those related to climate change, such as physical and transitional themes (e.g., policy, legal, technology, market, and reputational issues).
Timeframes. It is essential to assess the impacts in the short, medium and long term. Milestones to keep in mind are the 2030 Sustainable Development Goals (SDGs) and the 2050 global net-zero goal to keep warming under 1.5⁰C.
Coverage. Companies should assess impacts beyond their operations (i.e., their supply chain) given business materiality.
Type. Scenario analysis can be qualitative, quantitative, or some combination of both. Companies can start with a qualitative assessment of the impacts and then evolve into more quantitative assessments.
Current corporate strategy. This might include capital allocation decisions, research and development focus, expansion plans or planned new market entries.
Examples of scenarios on which companies can base their narratives:
Representative Concentration Pathways (RCP). These include four pathways with a range of GHG atmospheric concentrations.
Nationally Determined Contributions (NDC). These could be relevant according to the country where the company operates.
International Energy Agency IEA’s World Energy Outlook 2021. It considers four pathways including net-zero emissions by 2050.
IRENA’s 1.5⁰C Pathway. It builds on the Planned Energy Scenario (PES) with current ambitions to showcase a 1.5 Scenario (1.5-S) that also reaches net-zero by 2050.
Why is scenario analysis important?
As the adage goes, “the early bird catches the worm”. Actively thinking about exogenous circumstances for a business is good for two reasons: risks and opportunities.
Evaluating impacts under the different scenarios provides a better understanding of where vulnerabilities lie.
Business leaders can preserve business continuity if they constantly challenge the modus operandi to then plan around it.
Companies conducting risk and opportunity analysis will be able to lead and profit from opportunities arising under different scenarios.
Lack of preparedness results in potential business, strategic, and financial implications of climate-related risks.
Scenario analysis is, therefore, key for executive teams to support strategic and financial planning. It shines a spotlight on the resiliency of corporate strategies by revealing focus areas.
Why is it important for investors?
Simple answer: transparency! Documentation and disclosure of outputs are of particular interest to investors and asset managers. Transparent scenario analysis helps them evaluate risk more accurately, which ultimately influences capital allocation decisions.
A company that has a robust strategy advised by a series of plausible impacts safeguards returns. A company that (1) is aware of the potential impacts of climate-related risk exposure and (2) has a robust strategy in place is better equipped to safeguard its returns. Moreover, stress testing core business units and categories ultimately contributes to long-term value creation. This offers assurance that invested capital is being deployed in a business that is resilient, adaptable, and profitable in the long term.
What would investors like to see from their investees?
Publication of key inputs, assumptions, analytical methods and results, including potential business impacts, is crucial. An itemised list of the impacts identified as outputs helps investors, lenders, insurance underwriters, and other stakeholders understand the robustness of a company’s forward-looking strategy and financial plans across a range of possible future scenarios.
Furthermore, investors are keen to understand the roadmap of actions to mitigate and adapt in response to the risks and opportunities identified through scenario analysis. Therefore, pathways with interim and long-term actions can demonstrate that the findings of an assessment are being managed and incorporated into the business strategy. For example, Nestle’s Net Zero Roadmap sets a clear pathway of mitigation and adaptation actions addressing its supply chain exposure by transforming its product portfolio.
Why is scenario analysis especially relevant for the food and beverage industry?
Animal agriculture supply chains are particularly vulnerable to climate change, as evidenced in the Coller FAIRR Climate Risk Tool. For this reason, food retailers and manufacturers with high exposure to animal-derived proteins and ingredients are sure to benefit from conducting scenario analysis.
First, it helps companies understand where the risks and opportunities lie. This, of course, requires that impacts be assessed throughout the supply chain. Any analysis should then lead to actionable and tangible outcomes, which must be available to all relevant parties. After all, investors want to see the roadmaps and strategic thinking that follow scenario analysis as these will substantiate the company’s plan to harness opportunities and mitigate risks.
What are the companies in the engagement doing?
Our Sustainable Proteins engagement found that companies are following different pathways to understand their vulnerabilities and manage risk in their supply chains. During the past three years, the number of companies conducting scenario analysis has steadily increased. In 2021, 15 companies completed scenario analysis, of which 80% were conducted in alignment with TCFD recommendations. A further eight companies have confirmed their ongoing or planned work on scenario analysis and/or climate-risk assessment. Some examples are:
Climate Scenarios Used
Climate-related Risks Disclosed
It is the only company that has publicly disclosed impacts on animal protein supply chains and made a clear link between the mitigation actions taken in response to the findings of the analysis.
It has established a protein diversification strategy, with a target to increase the sales of plant-based meat by 300% by 2025 in response to animal agriculture supply chain vulnerabilities.
Scenario analysis pointed to the transition risks beef, milk, and chicken could suffer from a carbon tax on livestock.
It lacks disclosure of the variables used for physical risks assessed and the resulting impacts to animal protein supply chains.
Two scenarios, based on those developed by the Intergovernmental Panel on Climate Change (IPCC)
It identified 17 climate-related risk factors (both transition and physical risks) that could impact the company.
Findings informed the company’s business-wide climate strategy.
Public disclosure of the physical risks assessed in the medium and long term.
It lacks a link between its protein diversification efforts on its portfolio with climate-risk mitigation or the carbon reduction potential from the portfolio diversification.
2030 and 2050
Physical and transition
The Climate Change CDP report stated that plant-based proteins have a lower environmental impact and are more adaptable to climate change relative to animal-derived proteins.
Climate scenario informs the update of ingredients and inputs list for its R&D department.
It is tracking the % of total ingredient purchase classed as plant-based and increasing its plant-based product offering across brands.
It lacks disclosure of specific impacts to its animal agriculture supply chain.
“Various” without specifying a number.
2020 to 2040
Physical and transition
It has implemented a strategic response for its animal-protein exposure.
It has identified transition risks were the most impactful ‒market risk driven by behavioural shifting supply and demand.
It created a roadmap to transform its portfolio by replacing animal-derived ingredients.
It lacks disclosure of the actual impacts to animal-derived protein supply chains and the mitigation and adaptation efforts required for its key commodities, including dairy.
Three scenarios based on the IPCC and IEA
Physical and transition
It has included the impacts on its dairy supply chain.
It has disclosed outputs in general without discussing impacts specific to animal protein sources.
The most significant cost impacts would be on the cost of raw materials, without detailing which commodities nor the extent of the impact.
It does not quantify the mitigation and adaptation potential of plant-based products in its portfolio.
Two scenarios based on IPCC RPC 8.5, IEA, and Greenpeace energy revolution
Physical and transition
What is Scenario Analysis? Assessing impacts under several plausible future scenarios, prompting strategic thinking to mitigate risks and take advantage of opportunities.
Why is it important? It gives investors assurance that their capital is being deployed in a future-proofed business that is resilient, adaptable, and profitable in the long term. Also, this is especially relevant for the food industry as animal agriculture is significantly vulnerable to climate change.
Looking forward. There remains to be a lack of meaningful disclosure around findings and the use of scenario analysis to inform decision-making. Investors need transparency, specifically around the results of the analysis and the pathways of actions in the short, medium and long term.