making the most of uncertainy

8/12/2019 Making the Most of Uncertainy

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Making the most of uncertainty

Introduction:

The challenge of uncertainty has always perplexed businesses. With changes across the entire

spectrum of life taking place at unprecedented pace, facing uncertainly and its consequences has never

been more critical to the success of businesses. Business leaders are faced with the cumbersome

challenge of how best to lead their organizations during times of uncertainty. The traditional approach

to strategy requires precise predictions and thus often leads executives to underestimate uncertainty.

Making systematically sound strategic decisions under uncertainty requires rigorous and systematic

thinking as well as an approach that avoids biased and re-active view.

1. Cri tically evaluate two types of strategy - Shape and Adapt.The business context is an ever changing one. With fast paced changes in globalization, digitization

and new forms of capital markets, uncertainty in the business world has risen to a new height. This, in

turn, has changed the traditional definitions of opportunities and risks. In consequence, making the

right strategic choice for uncertain future has become a highly complex affair for the business

executives. Whereas the right strategic moves can return significant payoff in record time, the wrong

move can result in the complete collapse of global giants. There is always the option to wait for the

uncertainty to diminish and then take action. But it comes at the cost of foregoing the advantages of

being the first-mover. Determining the dominant solution to tap the most out of future potential thus

remains elusive.

Addressing uncertainty and making the most of it starts with understanding the available alternatives.

This is where choosing between shaping and adapting strategies becomes critical. Shapers

generally attempt to get ahead of uncertainty by driving industry to change in their way. Adapters, by

contrast, take the existing and future industry structure and conduct as given. When a market is stable,

adapters try to define defensible positions within the industrys existing structure. When high

uncertainty prevails, they attempt to win through speed and agility in recognizing and capturing new

opportunities as the market changes.

The level and nature of the uncertainty faced by an organization determines whether it should opt for

a shaping or adapting strategy. When it faces very high levels of uncertainty about variables it can

influence, shaping makes most sense. On the contrary, adapting is preferable when key sources of

value creation are relatively stable or outside the companys control.

In highly uncertain markets, technology standards change frequently, competitors constantly enter andexit, and consumers display lack of brand loyalty. These characteristics of a highly uncertain market

offer the greatest opportunity to implement successful shaping strategies. These strategies include, but

are not limited to, mergers / acquisitions, ambitious investment in technology, aggressive product-

bundling strategy. These actions re-shape the industry to a companys advantage.

In reality, executives tend to have a higher bias towards adapting strategies when faced with high

level of uncertainty. One probable reason for this tendency is their reliance of strategic planning tools

and processes that are not designed to handle highly uncertain business environment. These tools (e.g.

Michael Porters five forces framework, discounted cash-flow models, core competency diagnostics)

have the potential to provide deep insight into untapped opportunities in relatively stable markets. But

they are not intended to generate similar deep foresight into opportunities in rapidly changingcircumstances.


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In order to be successful shapers, organizations need to incorporate tools such as scenario planning

and game theory to have the foresight required to take full advantage of the opportunities offered by

high uncertainty. The organizations risk taking propensity plays an influential role in this case. A

risk-averse organization will not take a shaping strategy even with the most convincing case and

thereby miss out on huge potential gains.

There is lack of agreement among business executives on a dominant answer to the shape-or-adapt

problem. In reality, individual companies have made differing strategic choices that were not

consistent across all issues, business lines, and times. Analysis of historical data also supports that

there is no a one-size-fits-all answer. Under a research project, McKinsey analyzed the 50 "stars" with

the greatest sales, profit, and market capitalization growth from 1985 to 1995. The stars included not

only some computer and retail giants (such as Best Buy, Microsoft, Oracle, Sun Microsystems, The

Home Depot, and Wal-Mart) but also lesser-known industrial companies (M. S. Carriers), business-

services firms (Omnicon), health care companies (Biomet), and financial-services firms (Advanta).

The research suggests that 86 percent of the biggest business winners from the sample period

followed predominantly market-shaping strategies. Yet, the research clearly shows that adapters too

can win big.

2. How can these strategy be applied to manage var ious uncertain ties in a decision makingprocess?

Uncertainty is the fact of life and business. Probability is the guide for a good life and successful

business. The concept of probability occupies an important place in the decision making process,

whether the problem is one faced in business, in government, in the social sciences, or just in one's

own everyday personal life. In very few decision making situations is perfect informationall the

needed factsavailable. Most decisions are made in the face of uncertainty. Probability enters into

the process by playing the role of a substitute for certaintya substitute for complete knowledge.

Accessible strategically appropriate information tends to fall into two categories. First, it is often

possible to identify clear trends, such as market demographics, that can help define potential demand

for a company's future products or services. Second, with the right analysis, many factors that are

currently unknown to a company's management are in fact revealed - for instance, performance

attributes for current technologies, the elasticity of demand for certain stable categories of products,

and competitors' plans to expand capacity.

The uncertainty that remains after the best possible analysis has been undertaken is known asresidual

uncertainty. The outcome of an ongoing regulatory debate or the performance attributes of a

technology still in development are examples of residual uncertainty. In practice, residual uncertainty

facing most strategic-decision makers falls into one of four broad levels.

Level 1 - A clear enough future Level 2 - Alternative futures Level 3 - A range of futures Level 4 - True ambiguity

The following tables illustrate what can be known in each of these levels of uncertainty and what tools

can be used to analyse the outcomes, along with relevant examples.

A clear enough future Alternative futures

What can be known?A single forecast precise enough

for determining strategy

A few discrete outcomes thatdefine the future


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Analytic tools Traditional strategy toolkit Decision analysisOption valuation modelsGame theory

Examples

Strategy against low-cost airlineentrant

Long distance telephone carriersstrategy to enter deregulated

local-service marketCapacity strategies for chemical

plants

A range of futures True ambiguity

What can be known?A range of possible outcomes,

but no natural scenariosNo basis to forecast the future

Analytic toolsLatent demand researchTechnology forecasting

Scenario planning

Analogies and patternrecognition

Non-linear dynamic modelsExamples

Entering emerging markets, suchas India

Developing or acquiringemerging technologies inconsumer electronics

Entering the market for consumermulti-media applications

Entering the Russian market in1992

Strategy in level one: A clear enough future

In predictable business environments, most companies become adapters. Analysis is designed to

predict an industry's future landscape, and strategy involves making positioning choices about where

and how to compete. When the underlying analysis is sound, such strategies by definition consist of aseries of no-regrets moves.

Adapter strategies in level-one situations are not necessarily incremental or boring. For example,

Southwest Airlines' no-frills, point-to-point service was a highly innovative, value-creating adapter

strategy, as was Gateway 2000's low-cost assembly and direct-mail distribution strategy when it

entered the personal-computer market in the late 1980s. In both cases, managers identified

opportunities, in low-uncertainty environments, that could be developed within the existing market

structure. The best level-one adapters create value through innovations in their products or services or

through improvements in their business systems, without fundamentally changing the industry.

It is also possible to be a shaper in level-one situations, but that is risky and rare, since level-oneshapers, hoping fundamentally to alter long-standing industry structures and conduct, increase the

amount of residual uncertaintyfor themselves and their competitorsin otherwise predictable

markets. Consider the overnight delivery strategy of Federal Express. When the company entered the

mail-and-package delivery industry, a stable level-one business, FedEx's strategy in effect created

level three uncertainty for itself. In other words, even though the chief executive officer, Frederick W.

Smith, commissioned detailed consulting reports that confirmed the feasibility of his business

concept, only a broad range of potential demand for overnight services could be identified at the time.

For the industry incumbents, such as United Parcel Service, FedEx created level-two uncertainty.

FedEx's move raised two questions for UPS: Will the overnight delivery strategy succeed? And will

UPS have to offer a similar service to remain a viable competitor in the market? Over time, the

industry returned to level-one stability but with a fundamentally new structure. FedEx's bet paid off,

forcing the rest of the industry to adapt to the new demand for overnight services.


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Strategy in level two: Alternative futures

In level two, a shaping strategy is designed to increase the probability that a favoured industry

scenario will unfold. A shaper in a capital-intensive industry, such as pulp and paper, for example,

wants to prevent competitors from creating excess capacity that would destroy the industry's

profitability. Consequently, shapers in such cases might commit their companies to pre-empt

competition by building new capacity far in advance of an upturn in demand, or they might

consolidate the industry through mergers and acquisitions. But even the best shapers must be prepared

to adapt, such as Microsoft Network (MSN).

Microsoft Network (MSN) began as a shaping strategy, but in the battle between proprietary and open

networks, certain trigger variablesgrowth in the number of Internet and MSN subscribers, for

example, and the activity profiles of early MSN subscribersprovided valuable insight into how the

market was evolving. When it became clear that open networks would prevail, Microsoft refocused

the MSN concept on the Internet. Microsoft's shift shows that choices of strategic posture are not

carved in stone and underscores the value of maintaining strategic flexibility under uncertainty.

The best companies supplement their shaping bets with options that allow them to change coursequickly, if necessary. Because trigger variables are often fairly simple to monitor in level two, it can

be easy to adapt or reserve the right to play.

Strategy in level three: A range of futures

Shaping takes a different form in level three. If shapers at level two are trying to promote a discrete

outcome, at level three they are simply trying to move the market in a general direction because they

can identify only a range of possible outcomes. The battle over standards for electronic-cash

transactions is a good example in this case.

Mondex International, a consortium of financial-services providers and technology companies,

attempted to shape the future by establishing what it expected to become universal e-cash standards.

Its shaping posture was backed by big-bet investments in product development, infrastructure, and

pilot experiments to speed customer acceptance. In contrast, regional banks, which did not have the

deep pockets and skills necessary to set standards for the e-payment market but wanted to be able to

offer their customers the latest electronic services, mainly chose adapter strategies. An adapter posture

at uncertainty levels three or four is often achieved primarily through investments in organizational

capabilities designed to keep options open

Strategy in level four: True ambiguity

Level four situations involve the greatest uncertainty. But paradoxically, they may offer higher returns

and lower risks for companies seeking to shape the market than situations in levels two or three. Levelfour situations are transitional by nature, often emerging after major technological, macroeconomic,

or legislative shocks. Since no player necessarily knows the best strategy in these environments, the

shaper's role is to provide a vision of an industry structure and standards that will coordinate the

strategies of other players and drive the market toward a more stable and favourable outcome.

Mahathir Mohammad, Malaysia's prime-minister, was trying to shape the future of the multimedia

industry in Asia's Pacific Rim during late 90s. This was truly a level four strategy: potential products

were undefined, as were such factors as the players, the level of customer demand, and the technology

standards. The Malaysian government was trying to create order out of this chaos by investing at least

$15 billion to create a Multimedia Super Corridor, a 750-square-kilometer zone, south of Kuala

Lumpur, that would include state-of-the-art "smart" buildings for software companies, regionalheadquarters for multinational corporations, a "multimedia university," a paperless government centre


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called Putrajaya, and a new city called Cyberjaya. By leveraging incentives such as a ten-year

exemption from the tax on profits, the corridor received commitments from more than 40 Malaysian

and foreign companies, including such powerhouses as Intel, Microsoft, Nippon Telegraph and

Telephone, Oracle, and Sun Microsystems. Mahathir's shaping strategy was predicated on the notion

that the corridor would create a web of relationships between content and hardware providers and that

this web would generate clear industry standards and a set of complementary multimedia products andservices.

3. Why is it very impor tant to understand the uncertainti es under current business context toidentify the best-fit strategy?

The business environment is becoming increasingly complex and business leaders are continuously

challenged with escalating uncertainty. In recent years, numerous unforeseen and unpredicted events

have taken place, causing many businesses to fail. Business leaders have a better chance of avoiding

failures in future by prioritizing residual uncertainty (both short-term and long-term) on their agenda.

Leaders with the right mind-set will be able to track and evaluate multiple variables and global events

in preparing for facing an uncertain future and tackling the challenges head-on. It is these leaders whowill have a better chance of success the ever-changing business environment.

A good strategy in highly uncertain business environments begins with the plan for change. Planning

for change, as a process, is more disciplined, analytical and technical than many leaders realize. The

following four stages make up a successful plan for change:

1. Assessing the business context,2. Organizing the dimension of change,3. Designing the best fit approach to change and4. Delivering change.

Some executives seek to shape the future with high-stake bets. Eastman Kodak Company, for

example, spent $500 million per year during the late 90s to develop an array of digital photography

products it hoped would fundamentally change the way people create, store, and view pictures.

Meanwhile, Hewlett-Packard Company, during the same time, invested $50 million per year to pursue

a rival vision centred on home-based photo printers. Such industry-shaping strategies have the

potential to create enormous wealth, but most companies, in reality, lack the industry position, assets,

or appetite for risk necessary to make such strategies work.

More risk-averse executives hedge their bets by making a number of smaller investments. In pursuit

of growth opportunities in emerging markets, for example, many consumer-product companies have

been forging limited operational or distribution alliances. But its often difficult to determine if such

limited investments will work-out or not. Alternatively, some executives favour investments in

flexibility that allows their companies to adapt quickly as markets evolve. But the costs of

establishing such flexibility can be high. Moreover, taking a wait-and-see strategypostponing large

investments until the future becomes clearcan create a window of opportunity for competitors.

Executives facing great uncertainty need to decide whether to bet big, hedge, or take a wait and see

stance. But making this decision based on a traditional strategic planning process is most likely to be

ineffective. The standard practice is to lay out a vision of future events precise enough to be captured

in a discounted-cash-flow analysis. Of course, managers can discuss alternative scenarios and test

how sensitive their forecasts are to changes in key variables, but the goal of such analysis is often to

find the most likely outcome and create a strategy based on it. That approach serves companies well

in relatively stable business environments. But when there is greater uncertainty about the future, it isat best marginally helpful and at worst completely precarious.


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One danger is that this traditional approach leads executives to view uncertainty in a binary wayto

assume that the world is either certain, and therefore open to precise predictions about the future, or

uncertain, and therefore completely unpredictable. Planning or capital-budgeting processes that

require point forecasts force managers to bury underlying uncertainties in their cash flows. Such

systems clearly push managers to underestimate uncertainty in order to make a compelling case for

their strategy.

Underestimating uncertainty can lead to strategies that neither defend against the threats nor take

advantage of the opportunities that higher levels of uncertainty may provide. In one of the most

colossal underestimations in business history, Kenneth H. Olsen, the-then president of Digital

Equipment Corporation, announced in 1977, There is no reason for any individual to have a

computer in their home. The explosion in the personal computer market was not inevitable in 1977,

but it was certainly within the range of possibilities that industry experts were discussing at the time.

At the other extreme, assuming that the world is entirely unpredictable can lead managers to abandon

the analytical rigor of their traditional planning processes altogether and base their strategic decisions

primarily on gut instinct. This just do it approach to strategy can cause executives to placemisinformed bets on emerging products or markets that result in record write-offs.

Risk-averse managers who think they are in very uncertain environments do not trust their gut

instincts and suffer from decision paralysis. They avoid making critical strategic decisions about the

products, markets and technologies they should develop. Instead, they focus on re-engineering,

quality-management or internal cost reduction programs. Though these are valuable programs, they

are not the substitutes for a sound strategy.

Making systematically sound strategic decisions under uncertainty requires a different approachone

that avoids the risky binary view. It is rare that managers know absolutely nothing of strategic

importance, even in the most uncertain environments. In fact, they can usually identify a range of

potential outcomes or even a discrete set of scenarios. This simple insight is very powerful because

determining which strategy is best, and what process should be used to develop it, depend vitally on

the level of uncertainty a company faces.

Conclusion:

The relationship between uncertainty and business opportunity has been vague in empirical and

theoretical treatments. As executives make shape-or-adapt choices, uncertainty, perceived first-mover

advantages, and the organizations capabilities and aspirations play important roles. No algorithm

exists to weigh each factor, nor can a one-size-fits-all answer suit all organizations in all situations.

One thing, however, is certain: executives who develop a thorough understanding of the level and

nature of the residual uncertainty their company faces can develop a richer set of feasible alternativesand make better-informed choices to shape or adapt. While it is not possible to accurately predict

future developments and resulting outcomes, planning and developing a point of viewat every level

of the organization - is essential. This approach helps executives to remain open and receptive to new

ideas, to interact with a wider range of people, and thus assist in taking action even in the most

unstable times. Likewise, this approach gives a clear direction on how to prioritize the allocation of

key resources within the organization in preparation for the uncertain future.


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Works Cited

Courtney, Hugh. "McKinsey and Company." June 2000. 13 June 2014

.

Courtney, Hugh, Patric Viguerie and Jane Kirkland. "Strategy Under Uncertainty." Harbard Business

Review (1997): 5-9.

making the most of uncertainy

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