Role of scenario planning and probabilities in economic decision problems – literature review and new conclusions

Abstract

Purpose – scenario planning is very helpful when the decision maker deals with uncertain issues. Probabilities are also frequently applied to such problems. In the paper, we examine the correctness of combining probabilities with scenario planning in economic decisions which are usually made under uncertainty. The goal of the article is to find and discuss cases where the use of probabilities in scenario planning is appropriate and cases where such an approach is not desirable. Research methodology – in order to achieve this target, we first make a concise literature review of existing approaches concerning the application of probabilities to scenario planning. Then, we investigate and compare diverse decision making circumstances presented by means of numerical examples and differing from each other with regard to the nature of the decision problem (way of payoff estimation, novelty degree of the problem, access to historical data etc.) and the decision maker’s objectives and preferences (one-shot or multi-shots decisions, attitude towards risk). We explore the newsvendor problem, the spare parts quantity problem, the project selection problem and the project time management with scenario-based decision project graphs. Findings – the work contains both recommendations already described in the literature and suggestions formulated by the author. We get to the point that scenario planning is unquestionable support for decision making under uncertainty, however, the use of probabilities as an accompanying tool may be necessary and justified in some specific cases only. Their significance depends for instance on (1) the number of times a given variant is supposed to be executed; (2) the decision maker’s knowledge about the considered problem; (3) the novelty degree of the problem; (4) the decision maker’s conviction that the probability values really reflect his/her attitude towards risk. The analysis of numerical examples leads us to the conclusion that scenario planning should not be linked with the likelihood (1) for one-shot decisions problems; (2) for decision problems related to different kinds of innovation; (3) in the case of lack of certainty which type of probability definition ought to be applied to a given situation; (4) if the decision maker anticipates new future factors not included in historical data. Research limitations – in the paper we mainly analyse one-criterion problems and payoff matrices with data precisely defined. Further conclusions can be obtained after investigating multi-criteria cases and examples with interval payoffs. We limit our research to selected probability definitions. Nevertheless, a wider review can lead to new interesting observations. Practical implications – the aforementioned findings are crucial in such domains as economic modeling and decision theory. The results of the research can be used in planning, management, and decision optimization. They provide valuable guidelines for each decision maker dealing with an uncertain future. Originality/Value – authors of previous papers related to this topic have already formulated many significant conclusions. However, this contribution examines the problem from a new point of view since it concentrates on novel decisions, concerning unique, innovative or innovation projects (products). It encourages the decision makers to treat problems usually called in the literature “stochastic problems” (i.e. with known probability distribution) as “strategic problems” (i.e. with unknown probability distribution). This is especially the case of the newsvendor problem and the spare parts quantity problem.