Determine Which Economic Principle is Illustrated by Each Scenario

Determine Which Economic Principle is Illustrated by Each Scenario

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  • The Idea in Brief

    Are you using traditional analytic tools—market place research, value chain analysis, assessments of rivals—to inform your strategy? Those tools work in stable business organisation environments. Just today we’re operating amid unprecedented dubiety. Utilise the sometime tools, and you risk formulating strategies that neither defend your company against threats nor leverage the opportunities uncertainty can provide.

    Instead, employ analytic tools based on the
    level
    of uncertainty facing your visitor: Are you facing just two or iii alternative futures? So use tools such as decision analysis. A broad range of possible scenarios? Consider scenario planning. Armed with the correct kind of information, select an appropriate strategy—and execute information technology through savvy moves.

    For case, using scenario planning, financial-services provider Mondex International adamant that the advent of electronic cash transactions could create a range of possible futures. Mondex’s strategy? Shape its manufacture’southward future by establishing what it hoped would become universal electronic-cash standards. Its moves? Make big-bet investments in product development, complemented by more than conservative airplane pilot experiments to speed customer acceptance.

    Equally companies similar FedEx and Microsoft accept discovered, using the right tools to read the future enables you lot to avert disastrous strategic investments while exploiting fresh opportunities.

    The Idea in Exercise

    Confronting Uncertainty

    i. Use appropriate analytic tools to identify strategic options.

    If you envision:
    Only a few future scenarios

    Use:
    Option valuation models and game theory to institute relative probabilities of each outcome and guess alternative strategies’ risks and returns

    Example:

    A lurid and paper company cannot discover or predict its competitors’ plans for expanding capacity—which could strongly bear upon industry prices and profitability. Its determination whether to build a constitute will hinge on rivals’ decisions. A limited number of competitor moves are probable. The visitor evaluates the inherent risks and returns for each scenario, using game theory to identify probable market winners and losers for each.

    If you envision:
    A wide range of futures

    Use:
    Engineering forecasting and scenario planning to develop 4–5 possible scenarios

    Example:

    A consumer-appurtenances company considering inbound the Indian market place develops multiple scenarios characterized by different variables, such as customer-penetration rates and latent-demand level.

    two. Select a strategic posture.
    Strategic postures clarify your strategic intent. They can take three forms:

    • Shaping—driving your manufacture toward a new structure of your devising and creating new opportunities. Hewlett-Packard shifted photograph processing from stores to homes by offering high-quality, low-cost photo printers.
    • Adapting—choosing where and how to compete within the current manufacture construction. Many telecommunications service resellers pursue competitive reward through pricing and effective execution rather than product innovation.
    • Reserving the right to play—making incremental investments to stay in the game without committing to a new strategy prematurely. Some pharmaceutical companies reserve the right to play in gene-therapy applications past buying pocket-size biotech firms with relevant expertise.

    3. Build a portfolio of strategic moves.
    Use i or more of these moves depending on your strategic posture:

    • Big bets—major commitments (capital investments, mergers or acquisitions) that will generate large payoffs in some scenarios and large losses in others.
    • Options—small initial investments (airplane pilot trials, limited joint ventures, technology licensing) that enable you to ramp upward or scale back your investment later on as the market place evolves.
    • No-regrets moves—actions that pay off no matter what happens, such equally cost-cut initiatives and competitor intelligence.


    Case:

    Chemical companies often use options to reserve the right to play when emerging technologies’ operation is uncertain. Rather than retrofitting old plants effectually an unproven new technology, they purchase options to license the technology within a specified time frame or retrofit a few facilities with the emerging engineering. These small-scale, up-forepart commitments position them to ramp up or discontinue evolution of the engineering science equally its operation becomes clearer.

    What makes for a good strategy in highly uncertain business environments? Some executives seek to shape the hereafter with loftier-stakes bets. Eastman Kodak Visitor, for example, is spending $500 million per yr to develop an array of digital photography products that it hopes will fundamentally alter the way people create, store, and view pictures. Meanwhile, Hewlett-Packard Visitor is investing $50 meg per year to pursue a rival vision centered around home-based photo printers. The business press loves to hype such industry-shaping strategies considering of their potential to create enormous wealth, but the sober reality is that most companies lack the industry position, assets, or ambition for hazard necessary to make such strategies piece of work.

    More risk-averse executives hedge their bets by making a number of smaller investments. In pursuit of growth opportunities in emerging markets, for case, many consumer-product companies are forging express operational or distribution alliances. But information technology’s ofttimes

    difficult to determine if such express investments truly reserve the right to play in these countries or just reserve the correct to lose.

    Alternatively, some executives favor investments in flexibility that let their companies to adapt quickly as markets evolve. But the costs of establishing such flexibility tin be high. Moreover, taking a await-and-see strategy—postponing large investments until the future becomes clear—can create a window of opportunity for competitors.

    How should executives facing great uncertainty determine whether to bet big, hedge, or expect and come across? Chances are, traditional strategic-planning processes won’t help much. The standard do is to lay out a vision of future events precise enough to be captured in a discounted-greenbacks-flow assay. Of course, managers tin talk over alternative scenarios and test how sensitive their forecasts are to changes in key variables, simply the goal of such analysis is often to detect the nearly probable 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 is at best marginally helpful and at worst downright dangerous.

    Under dubiousness, traditional approaches to strategic planning tin be downright dangerous.

    One danger is that this traditional arroyo leads executives to view uncertainty in a binary manner—to assume that the globe is either sure, and therefore open to precise predictions well-nigh the future, or uncertain, and therefore completely unpredictable. Planning or capital-budgeting processes that require betoken forecasts force managers to bury underlying uncertainties in their cash flows. Such systems conspicuously push button managers to underestimate uncertainty in society to make a compelling case for their strategy.

    Underestimating doubtfulness tin lead to strategies that neither defend against the threats nor take advantage of the opportunities that higher levels of dubiety may provide. In one of the most colossal underestimations in business concern history, Kenneth H. Olsen, and so president of Digital Equipment Corporation, announced in 1977 that “there is no reason for any private to have a computer in their dwelling house.” 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 fourth dimension.

    At the other extreme, assuming that the world is entirely unpredictable tin lead managers to abandon the analytical rigor of their traditional planning processes birthday and base of operations their strategic decisions primarily on gut instinct. This “only do information technology” approach to strategy can cause executives to place misinformed bets on emerging products or markets that result in record write-offs. Those who took the plunge and invested in habitation cyberbanking in the early 1980s immediately come to mind.

    Take chances-averse managers who think they are in very uncertain environments don’t trust their gut instincts and suffer from conclusion paralysis. They avoid making disquisitional strategic decisions most the products, markets, and technologies they should develop. They focus instead on reengineering, quality management, or internal cost-reduction programs. Although valuable, those programs are not substitutes for strategy.

    Making systematically sound strategic decisions nether uncertainty requires a different approach—1 that avoids this dangerous binary view. Information technology is rare that managers know admittedly nothing of strategic importance, even in the well-nigh uncertain environments. In fact, they usually can identify a range of potential outcomes or even a discrete prepare of scenarios. This simple insight is extremely powerful considering determining which strategy is best, and what process should be used to develop it, depend vitally on the level of dubiety a company faces.

    What follows, then, is a framework for determining the level of doubtfulness surrounding strategic decisions and for tailoring strategy to that uncertainty. No approach can make the challenges of uncertainty become abroad, but this one offers applied guidance that will lead to more informed and confident strategic decisions.

    Four Levels of Doubt

    Even the most uncertain business concern environments incorporate a lot of strategically relevant information. Kickoff, it is oft possible to identify clear trends, such every bit market demographics, that can help define potential demand for hereafter products or services. Second, there is usually a host of factors that are currently
    unknown
    only that are in fact
    knowable—that could be known if the right analysis were done. Functioning attributes for current technologies, elasticities of demand for certain stable categories of products, and competitors’ capacity-expansion plans are variables that are often unknown, but not entirely unknowable.

    The uncertainty that remains after the best possible analysis has been done is what we phone call
    residual doubt—for example, the outcome of an ongoing regulatory debate or the performance attrib-utes of a technology still in development. But often, quite a bit can be known most even those rest uncertainties. In practice, we have found that the residual dubiousness facing near strategic-decision makers falls into ane of four broad levels:

    Level i: A Clear-Enough Hereafter.

    At level 1, managers can develop a single forecast of the future that is precise
    enough
    for strategy development. Although it will be inexact to the degree that all business environments are inherently uncertain, the forecast will exist sufficiently narrow to point to a single strategic management. In other words, at level i, the residual uncertainty is irrelevant to making strategic decisions.

    Consider a major airline trying to develop a strategic response to the entry of a depression-toll, no-frills competitor into one of its hub airports. Should it respond with a low-cost service of its own? Should it cede the depression-cost niche segments to the new entrant? Or should information technology compete aggressively on cost and service in an attempt to bulldoze the entrant out of the market?

    To make that strategic decision, the airline’southward executives need market research on the size of unlike customer segments and the likely response of each segment to different combinations of pricing and service. They also need to know how much it costs the competitor to serve, and how much chapters the competitor has for, every route in question. Finally, the executives need to know the new entrant’s competitive objectives to anticipate how it would answer to any strategic moves their airline might make. In today’south U.S. airline industry, such data is either known already or is possible to know. Information technology might not be easy to obtain—it might require new market research, for case—but it is inherently knowable. And once that information is known, residual uncertainty would be limited, and the incumbent airline would exist able to build a confident concern instance effectually its strategy.

    Level 2: Alternating Futures.

    At level 2, the futurity can exist described as i of a few alternate outcomes, or
    discrete scenarios.
    Analysis cannot identify which effect will occur, although it may help establish probabilities. Most important, some, if not all, elements of the strategy would modify if the effect were predictable.

    Many businesses facing major regulatory or legislative change confront level 2 uncertainty. Consider U.S. long-altitude phone providers in late 1995, as they began developing strategies for inbound local phone markets. By late 1995, legislation that would fundamentally deregulate the industry was pending in Congress, and the wide grade that new regulations would take was fairly clear to most industry observers. Just whether or not the legislation was going to pass and how apace it would be implemented in the event it did pass were uncertain. No corporeality of assay would allow the long-altitude carriers to predict those outcomes, and the right class of action—for instance, the timing of investments in network infrastructure—depended on which upshot occurred.

    In another common level 2 state of affairs, the value of a strategy depends mainly on competitors’ strategies, and those cannot nonetheless be observed or predicted. For example, in oligopoly markets, such as those for pulp and paper, chemicals, and basic raw materials, the main doubtfulness is often competitors’ plans for expanding capacity: Will they build new plants or non? Economies of scale frequently dictate that any plant built would be quite large and would be likely to take a pregnant bear on on industry prices and profitability. Therefore, any one company’s decision to build a plant is often contingent on competitors’ decisions. This is a classic level 2 state of affairs: The possible outcomes are detached and clear. It is hard to predict which 1 volition occur. And the all-time strategy depends on which one does occur.


    How to Utilize the Iv Levels of Doubt

    Level three: A Range of Futures.

    At level 3, a range of potential futures can be identified. That range is defined by a limited number of key variables, but the bodily outcome may lie anywhere along a continuum divisional past that range. There are no natural discrete scenarios. Every bit in level 2, some, and mayhap all, elements of the strategy would alter if the outcome were predictable.

    Companies in emerging industries or entering new geographic markets often face up level three uncertainty. Consider a European consumer-appurtenances visitor deciding whether to introduce its products to the Indian market. The best possible market research might identify only a broad range of potential customer-penetration rates—say, from 10% to 30%—and there would be no obvious scenarios within that range. Such a broad range of estimates would be common when introducing completely new products and services to a market, and therefore determining the level of latent demand is very difficult. The visitor entering India would exist likely to follow a very different and more aggressive entry strategy if it knew for sure that its customer penetration rates would be closer to 30% than to 10%.

    Analogous problems exist for companies in fields driven by technological innovation, such as the semiconductor industry. When deciding whether to invest in a new technology, producers can ofttimes estimate only a broad range of potential cost and functioning attributes for the applied science, and the overall profitability of the investment depends on those attributes.

    Level iv: True Ambiguity.

    At level iv, multiple dimensions of uncertainty interact to create an surround that is near incommunicable to predict. Unlike in level 3 situations, the range of potential outcomes cannot be identified, let solitary scenarios within that range. Information technology might not even exist possible to identify, much less predict, all the relevant variables that will define the future.

    Level 4 situations are quite rare, and they tend to drift toward one of the other levels over time. Nevertheless, they practice exist. Consider a telecommunications company deciding where and how to compete in the emerging consumer-multimedia market. Information technology is confronting multiple uncertainties concerning technology, demand, and relationships between hardware and content providers, all of which may collaborate in ways so unpredictable that no plausible range of scenarios can be identified.

    Companies because making major entry investments in post-Communist Russia in 1992 faced level 4 dubiety. They could not outline the potential laws or regulations that would govern property rights and transactions. That cardinal uncertainty was compounded by additional uncertainty over the viability of supply chains and the demand for previously unavailable consumer appurtenances and services. And shocks such equally a political assassination or a currency default could accept spun the whole system toward completely unforeseen outcomes.

    Those examples illustrate how difficult strategic decisions can be at level iv, but they likewise underscore their transitory nature. Greater political and regulatory stability has turned decisions nigh whether to enter Russian markets into level 3 problems for the bulk of industries today. Similarly, doubtfulness about strategic decisions in the consumer multimedia marketplace will drift to level 3 or to level 2 as the industry begins to accept shape over the next several years.

    Tailoring Strategic Analysis to the Four Levels of Uncertainty

    Our experience suggests that at least half of all strategy problems fall into levels 2 or 3, while most of the rest are level 1 problems. But executives who think about dubiety in a binary style tend to treat all strategy problems equally if they fell into either level 1 or level 4. And when those executives base of operations their strategies on rigorous analysis, they are most likely to apply the aforementioned set of analytic tools regardless of the level of residuum uncertainty they face. For example, they might attempt to use standard, quantitative market-enquiry techniques to forecast demand for data traffic over wireless communications networks as far out as ten years from now.

    Just, in fact, a different kind of analysis should be done to place and evaluate strategy options at each level of uncertainty. All strategy making begins with some form of situation analysis—that is, a picture of what the world will look similar today and what is likely to happen in the future. Identifying the levels of uncertainty thus helps ascertain the best such an analysis can practice to describe each possible futurity an industry faces.

    To assist generate level 1’southward usefully precise prediction of the future, managers can use the standard strategy tool kit—market place research, analyses of competitors’ costs and capacity, value chain analysis, Michael Porter’southward five-forces framework, and and then on. A discounted-cash-menses model that incorporates those predictions can then be used to decide the value of various alternative strategies. It’due south not surprising that most managers experience extremely comfortable in level ane situations—these are the tools and frameworks taught in every leading business program in the United States.

    Level 2 situations are a flake more complex. First, managers must develop a set of discrete scenarios based on their understanding of how the cardinal resid-ual uncertainties might play out—for instance, whether deregulation occurs or not, a competitor builds a new found or non. Each scenario may require a unlike valuation model—full general industry construction and conduct will often be fundamentally dissimilar depending on which scenario occurs, and then alternative valuations tin’t be handled by performing sensitivity analyses around a unmarried baseline model. Getting information that helps found the relative probabilities of the alternative outcomes should be a high priority.

    After establishing an appropriate valuation model for each possible effect and determining how probable each is likely to exist, a classic decision-analysis framework tin can exist used to evaluate the risks and returns inherent in alternative strategies. This process will identify the likely winners and losers in culling scenarios, and possibly more than important, it will assist quantify what’s at pale for companies that follow status quo strategies. Such an analysis is often the key to making the case for strategic alter.

    In level 2 situations, it is important not only to place the different possible future outcomes but also to recollect through the probable paths the industry might take to attain those alternative futures. Will change occur in major steps at some particular point in time, post-obit, for instance, a regulatory ruling or a competitor’s decision to enter the market? Or will alter occur in a more evolutionary fashion, every bit oft happens afterwards a resolution of competing technology standards? This is vital data because it determines which market place signals or trigger variables should be monitored closely. As events unfold and the relative probabilities of alternative scenarios modify, it is likely that one’s strategy volition also need to be adjusted to these changes.

    At one level, the analysis in level 3 is very similar to that in level 2. A set of scenarios needs to be identified that describes culling time to come outcomes, and analysis should focus on the trigger events signaling that the market is moving toward one or some other scenario. Developing a meaningful prepare of scenarios, notwithstanding, is less straightforward in level 3. Scenarios that draw the farthermost points in the range of possible outcomes are often relatively easy to develop, merely these rarely provide much concrete guidance for current strategic decisions. Since there are no other natural discrete scenarios in level 3, deciding which possible outcomes should exist fully adult into alternative scenarios is a real art. But at that place are a few general rules. First, develop but a limited number of alternative scenarios—the complexity of juggling more than 4 or five tends to hinder decision making. 2d, avoid developing redundant scenarios that have no unique implications for strategic decision making; make sure each scenario offers a distinct picture of the industry’s structure, behave, and operation. Third, develop a prepare of scenarios that collectively account for the
    probable
    range of future outcomes and non necessarily the entire
    possible
    range.

    Considering it is impossible in level 3 to define a complete listing of scenarios and related probabilities, it is incommunicable to calculate the expected value of different strategies. Nevertheless, establishing the range of scenarios should allow managers to determine how robust their strategy is, place likely winners and losers, and make up one’s mind roughly the risk of following status quo strategies.

    Situation analysis at level 4 is even more qualitative. Still, it is critical to avoid the urge to throw ane’s easily upwardly and act purely on gut instinct. Instead, managers need to catalog systematically what they know and what is possible to know. Even if information technology is impossible to develop a meaningful set up of probable, or even possible, outcomes in level 4 situations, managers can gain valuable strategic perspective. Normally, they can identify at to the lowest degree a subset of the variables that will determine how the market will evolve over time—for example, customer penetration rates or technology performance attributes. And they can place favorable and unfavorable indicators of these variables that will permit them rail the market’southward development over fourth dimension and suit their strategy as new information becomes bachelor.

    At level 4, it is disquisitional to avert the urge to throw upward your hands and act purely on gut instinct.

    Managers can besides identify patterns indicating possible ways the marketplace may evolve by studying how analogous markets adult in other level four situations, determining the key attributes of the winners and losers in those situations and identifying the strategies they employed. Finally, although it will be incommunicable to quantify the risks and returns of different strategies, managers should be able to place what information they would have to believe almost the future to justify the investments they are considering. Early market indicators and analogies from similar markets will assistance sort out whether such behavior are realistic or not.

    Uncertainty demands a more flexible approach to situation assay. The old one-size-fits-all arroyo is but inadequate. Over fourth dimension, companies in most industries will confront strategy problems that have varying levels of balance uncertainty, and it is vitally important that the strategic analysis be tailored to the level of uncertainty.

    The old one-size-fits-all analytic approach to evaluating strategy options is simply inadequate.

    Postures and Moves

    Earlier we can talk about the dynamics of formulating strategy at each level of uncertainty, we demand to introduce a basic vocabulary for talking about strategy. First, at that place are three
    strategic postures
    a visitor tin can choose to take vis-à-vis uncertainty: shaping, adapting, or reserving the correct to play. 2d, there are three types of moves in the
    portfolio of actions
    that can be used to implement that strategy: big bets, options, and no-regrets moves.

    Strategic Posture.

    Whatever good strategy requires a option about strategic posture. Fundamentally,
    posture
    defines the intent of a strategy relative to the current and futurity state of an industry.
    Shapers
    aim to drive their industries toward a new structure of their own devising. Their strategies are about creating new opportunities in a market—either by shaking upwards relatively stable level i industries or past trying to command the management of the market place in industries with higher levels of uncertainty. Kodak, for case, through its investment in digital photography, is pursuing a shaping strategy in an attempt to maintain its leadership position, as a new engineering science supersedes the 1 currently generating nigh of its earnings. Although its product engineering science is new, Kodak’due south strategy is nonetheless based on a traditional model in which the visitor provides digital cameras and film while photo-processing stores provide many of the photo-printing and storage functions for the consumer. Hewlett-Packard also seeks to exist a shaper in this market, only it is pursuing a radically different model in which high-quality, low-cost photo printers shift photograph processing from stores to the domicile.

    The Three Strategic Postures

    In contrast,
    adapters
    accept the current industry structure and its future evolution as givens, and they react to the opportunities the market place offers. In environments with little doubt, adapters choose a strategic positioning—that is, where and how to compete—in the current industry. At higher levels of dubiety, their strategies are predicated on the ability to recognize and respond quickly to market developments. In the highly volatile telecommunications-service industry, for example, service resellers are adapters. They buy and resell the latest products and services offered by the major telecom providers, relying on pricing and effective execution rather than on production innovation as their source of competitive advantage.

    The tertiary strategic posture,
    reserving the right to play,
    is a special form of adapting. This posture is relevant merely in levels 2 through 4; it involves making incremental investments today that put a visitor in a privileged position, through either superior data, price structures, or relationships between customers and suppliers. That allows the company to wait until the environment becomes less uncertain before formulating a strategy. Many pharmaceutical companies are reserving the right to play in the marketplace for gene therapy applications by acquiring or allying with small-scale biotech firms that have relevant expertise. Providing privileged access to the latest manufacture developments, these are low-cost investments compared with building a proprietary, internal cistron-therapy R&D programme.

    A Portfolio of Actions.

    A posture is not a complete strategy. Information technology clarifies strategic intent only not the actions required to fulfill that intent. 3 types of moves are peculiarly relevant to implementing strategy nether conditions of incertitude: large bets, options, and no-regrets moves.

    Big bets
    are large commitments, such as major capital investments or acquisitions, that volition issue in large payoffs in some scenarios and big losses in others. Not surprisingly, shaping strategies usually involve big bets, whereas adapting and reserving the right to play do not.

    Options
    are designed to secure the big payoffs of the best-instance scenarios while minimizing losses in the worst-case scenarios. This asymmetric payoff structure makes them resemble financial options. Most options involve making minor initial investments that will allow companies to ramp upwards or scale back the investment after as the market evolves. Classic examples include conducting airplane pilot trials before the full-calibration introduction of a new production, entering into limited articulation ventures for distribution to minimize the risk of breaking into new markets, and licensing an alternative technology in case it proves to be superior to a current technology. Those reserving the right to play rely heavily on options, but shapers use them also, either to shape an emerging just uncertain market every bit an early on mover or to hedge their big bets.

    Finally,
    no-regrets moves
    are only that—moves that will pay off no matter what happens. Managers ofttimes focus on obvious no-regrets moves like initiatives aimed at reducing costs, gather-ing competitive intelligence, or building skills. However, fifty-fifty in highly uncertain environments, strategic decisions similar investing in capacity and entering sure markets can exist no-regrets moves. Whether or not they put a name to them, about managers understand intuitively that no-regrets moves are an essential element of any strategy.

    The choice of a strategic posture and an accompanying portfolio of actions sounds straightforward. But in practice, these decisions are highly dependent on the level of doubtfulness facing a given business organisation. Thus the four-level framework can help analyze the practical implications implicit in whatever choice of strategic posture and actions. The discussion that follows volition demonstrate the different stra-tegic challenges that each level of dubiousness poses and how the portfolio of deportment may be practical.

    What’s in a Portfolio of Deportment?

    Strategy in Level 1’s Articulate-Enough Hereafter.

    In predictable business environments, most companies are adapters. Assay is designed to predict an industry’s futurity landscape, and strategy involves making positioning choices almost where and how to compete. When the underlying analysis is sound, such strategies are past definition made up of a serial of no-regrets moves.

    Adapter strategies in level ane situations are not necessarily incremental or boring. For example, Southwest Airlines Company’s no-frills, point-to-betoken service is a highly innovative, value-creating adapter strategy, as was Gateway 2000’southward low-cost assembly and direct-mail distribution strategy when it entered the personal figurer market in the late 1980s. In both cases, managers were able to place unexploited opportunities in relatively depression-incertitude environments within the existing market place structure. The best level 1 adapters create value through innovations in their products or services or through improvements in their business organisation systems without otherwise fundamentally irresolute the industry.

    Information technology is also possible to be a shaper in level 1 situations, only that is risky and rare, since level 1 shapers increment the amount of residual uncertainty in an otherwise predictable market—for themselves and their competitors—in an attempt to fundamentally alter long-standing industry structures and comport. Consider Federal Express Corporation’south overnight-commitment strategy. When it entered the mail-and-package delivery manufacture, a stable level 1 situation, FedEx’s strategy in effect created level 3 uncertainty for itself. That is, even though CEO Frederick W. Smith deputed 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 like United Package Service, FedEx created level two uncertainty. FedEx’south movement raised two questions for UPS: Will the overnight-delivery strategy succeed or non? and Will UPS have to offer a like service to remain a viable competitor in the market?

    Over fourth dimension, the manufacture returned to level ane stability, but with a fundamentally new structure. FedEx’s bet paid off, forcing the rest of the industry to adjust to the new demand for overnight services.

    What portfolio of deportment did it take to realize that strategy? Similar most shaper strategies, even in level 1 situations, this i required some large bets. That said, it often makes sense to build options into a shaper strategy to hedge confronting bad bets. Smith might accept hedged his bets past leasing existing cargo airplanes instead of purchasing and retrofitting his original fleet of Falcon “minifreighters,” or he could have outsourced basis pickup and delivery services. Such moves would have limited the corporeality of capital he would have needed to sink into his new strategy and facilitated a graceful exit had his concept failed. Notwithstanding, that kind of insurance doesn’t e’er come cheap. In FedEx’due south case, had Smith leased standard-size cargo planes, he would have come nether the restrictive regulations of the Civil Aeronautics Board. And outsourcing local pickups and deliveries would have diluted FedEx’due south unique door-to-door value to customers. Thus Smith stuck mainly to big bets in implementing his strategy, which collection him to the brink of bankruptcy in his first two years of performance merely ultimately reshaped an entire industry.

    Strategy in Level 2’south Alternate Futures.

    If shapers in level 1 try to heighten incertitude, in levels 2 through 4 they try to lower uncertainty and create order out of chaos. In level two, a shaping strategy is designed to increase the probability that a favored industry scenario will occur. A shaper in a majuscule-intensive industry like pulp and paper, for example, wants to prevent competitors from creating backlog capacity that would destroy the manufacture’south profitability. Consequently, shapers in such cases might commit their companies to building new capacity far in advance of an upturn in demand to preempt the competition, or they might consolidate the manufacture through mergers and acquisitions.

    Consider the Microsoft Network (MSN). A few years ago, one could place a discrete fix of possible ways in which transactions would be conducted between networked computers. Either proprietary networks such as MSN would become the standard, or open networks similar the Internet would prevail. Doubtfulness in this situation was thus at level 2, even though other related strategy issues—such equally determining the level of consumer demand for networked applications—were level 3 problems.

    Microsoft could reasonably look to shape the way markets for electronic commerce evolved if it created the proprietary MSN network. Information technology would, in event, be building a commerce hub that would link both suppliers and consumers through the MSN gateway. The strategy was a large bet: the development costs were significant and, more of import, involved an enormously loftier level of industry exposure and attention. In effect, for Microsoft, information technology constituted a large credibility bet. Microsoft’s activities in other areas—such every bit including one-button access to MSN from Windows95—were designed to increment the probability that this shaping bet would pay off.

    Just fifty-fifty the best shapers must be prepared to adapt. In the battle betwixt proprietary and open up networks, certain trigger variables—growth in the number of Internet and MSN subscribers, for example, or the activity profiles of early MSN subscribers—could provide valuable insight into how the market was evolving . When it became clear that open up networks would prevail, Microsoft refocused the MSN concept around the Internet. Microsoft’south shift illustrates that choices of strategic posture are not carved in stone, and it underscores the value of maintaining strategic flexibility under uncertainty. Shaping strategies can fail, then the best companies supplement their shaping bets with options that permit them to change grade quickly if necessary. Microsoft was able to practise just that considering it remained flexible by being willing to cut its losses, by building a cadre of engineers who had a wide range of full general-programming and product-evolution skills, and by closely monitoring key trigger variables. In uncertain environments, information technology is a mistake to let strategies run on autopilot, remaining content to update them only through standard twelvemonth-end strategy reviews.

    Shaping strategies can neglect, so the best companies supplement their shaping bets with options that let them change course quickly.

    Considering trigger variables are ofttimes relatively simple to monitor in level two, information technology tin be easy to adapt or reserve the correct to play. For example, companies that generate electricity—and others whose concern depends on energy-intensive production processes—oftentimes face level 2 incertitude in determining the relative cost of unlike fuel alternatives. Discrete scenarios tin can oft be identified—for instance, either natural gas or oil will be the depression-cost fuel. Many companies thus cull an adapter strategy when building new plants: they construct flexible manufacturing processes that can switch hands between different fuels.

    Chemic companies frequently choose to reserve the right to play when facing level 2 uncertainty in predicting the operation of a new technology. If the technology performs well, companies will take to employ information technology to remain competitive in the market. Only if information technology does non fulfill its promise, incumbents can compete effectively with existing technologies. Most companies are reluctant to bet several hundred meg dollars on edifice new chapters and retrofitting former plants effectually a new applied science until information technology is proven. But if they don’t make at least incremental investments in the short run, they risk falling as well far behind competitors should the engineering succeed. Thus many will purchase options to license the new technology within a specified time frame or brainstorm retrofitting a proportion of existing capacity around the new engineering science. In either case, minor, upwards-front commitments give the companies privileged positions, but not obligations, to ramp upward or discontinue evolution of the new engineering equally its performance attributes become clearer over time.

    Strategy in Level 3’s Range of Futures.

    Shaping takes a different grade in level three. If at level ii, shap-ers are trying to make a discrete outcome occur, at level 3, they are trying to move the market in a general direction considering they tin can identify but a range of possible outcomes. Consider the battle over standards for electronic greenbacks transactions, currently a level three problem since 1 tin can define a range of potential products and services that fall between purely paper-based and purely electronic greenbacks transactions, but it is unclear today whether there are any natural discrete scenarios within that range. Mondex International, a consortium of financial services providers and technol-ogy companies, is attempting to shape the future by establishing what it hopes volition become universal electronic-greenbacks standards. Its shaping posture is backed by big-bet investments in product development, infrastructure, and pilot experiments to speed client credence.

    In contrast, regional banks are mainly choosing adapter strategies. An adapter posture at uncertainty levels iii or four is often achieved primarily through investments in organizational capabilities designed to go on options open. Because they must make and implement strategy choices in existent time, adapters need quick admission to the best market information and the most flexible organizational structures. Many regional banks, for example, take put in place steering committees focused on electronic payments, R&D projects, and competitive-intelligence systems so that they tin constantly monitor developments in electronic payment technology and markets. In addition, many regional banks are making small investments in industry consortia as another way to monitor events. This adapter approach makes sense for most regional banks—they don’t have the deep pockets and skills necessary to set standards for the electronic payment market, still it is essential that they be able to offer the latest electronic services to their customers as such services get bachelor.

    Reserving the right to play is a common posture in level 3. Consider a telecommunications company trying to decide whether to make a $1 billion investment in broadband cable networks in the early 1990s. The determination hinged on level 3 uncertainties such as demand for interactive Goggle box service. No amount of solid market place research could precisely forecast consumer demand for services that didn’t even exist yet. However, making incremental investments in broadband-network trials could provide useful information, and it would put the visitor in a privileged position to aggrandize the business in the futurity should that show attractive. By restructuring the broadband-investment determination from a big bet to a series of options, the company reserved the right to play in a potentially lucrative marketplace without having to bet the subcontract or adventure being preempted past a competitor.

    How a Regional Bank Confronts the Uncertainties in Electronic Commerce

    Strategy in Level 4’s Truthful Ambivalence.

    Paradoxically, fifty-fifty though level four situations comprise the greatest dubiety, they may offer higher returns and involve lower risks for companies seeking to shape the market than situations in either level 2 or 3. Recollect that level iv situations are transitional by nature, frequently occurring after a major technologi-cal, macroeconomic, or legislative shock. Since no player necessarily knows the best strategy in these environments, the shaper’southward role is to provide a vision of an industry construction and standards that will coordinate the strategies of other players and drive the market place toward a more stable and favorable result.

    Mahathir bin Mohamad, Malaysia’due south prime government minister, is trying to shape the future of the multimedia industry in the Asian Pacific Rim. This is truly a level four strategy problem at this betoken. Potential products are undefined, as are the players, the level of client demand, and the technology standards, among other factors. The government is trying to create order out of this anarchy by investing at least $15 billion to create a so-called Multimedia Super Corridor (MSC) in Malaysia. The MSC is a 750-foursquare-kilometer zone south of Kuala Lumpur that volition include country-of-the-fine art “smart” buildings for software companies, regional headquarters for multinational corporations, a “Multimedia Academy,” a paperless government heart chosen Putrajaya, and a new city called Cyberjaya. By leveraging incentives like a x-yr exemption from the tax on profits, the MSC has received commitments from more than than twoscore Malaysian and strange companies so far, including such powerhouses as Intel, Microsoft, Nippon Telegraph and Phone, Oracle, and Dominicus Microsystems. Mahathir’s shaping strategy is predicated on the notion that the MSC will create a web of relationships between content and hardware providers that volition result in clear industry standards and a prepare of complementary multimedia products and services. Intel’s Malaysia managing director, David B. Marsing, recognized Mahathir’s shaping aspirations when he noted, “If you’re an evolutionist, it’s foreign. They’re [the Malaysian authorities] trying to intervene instead of letting it evolve.”

    Shapers need not brand enormous bets as the Malaysian government is doing to be successful in level 3 or iv situations, however. All that is required is the credibility to coordinate the strategies of different players around the preferred outcome. Netscape Communications Corporation, for example, didn’t rely on deep pockets to shape Internet browser standards. Instead, it leveraged the credibility of its leadership team in the industry so that other industry players thought, “If these guys call back this is the way to go, they must be correct.”

    Netscape relied on its brownie, rather than deep pockets, to shape Internet browser standards.

    Reserving the right to play is common, but potentially unsafe, in level four situations. Oil companies believed they were reserving the right to compete in China by buying options to establish various beachheads there some 20 years agone. However, in such level 4 situations, it is extremely difficult to determine whether incremental investments are truly reserving the right to play or simply the right to lose. A few general rules apply. Showtime, await for a high degree of leverage. If the option of beachhead in China comes down to maintaining a small-scale, but expensive, local operation or developing a limited joint venture with a local distributor, all else being equal, go for the depression-cost option. Higher-cost options must exist justified with explicit arguments for why they would put the company in a improve position to ramp up over time. Second, don’t get locked into one position through neglect. Options should be rigorously reevaluated whenever important uncertainties are clarified—at least every half dozen months. Call back, level four situations are transitional, and most will apace move toward levels 3 and 2.

    The difficulty of managing options in level 4 situations often drives players toward adapter postures. Every bit in level 3, an adapter posture in level 4 is frequently implemented by making investments in organizational capabilities. Most potential players in the multimedia industry are adopting that posture today only will soon be making bigger bets every bit the manufacture moves into level iii and ii uncertainty over fourth dimension.

    A New Approach to Uncertainty

    At the heart of the traditional approach to strategy lies the assumption that past applying a set of powerful analytic tools, executives can predict the future of whatsoever business accurately enough to allow them to choose a clear strategic direction. In relatively stable businesses, that arroyo continues to work well. Merely information technology tends to interruption down when the environment is and then uncertain that no amount of good analysis will allow them to predict the future.

    Levels of uncertainty regularly confronting managers today are so loftier that they need a new way to think about strategy. The approach we’ve outlined will aid executives avoid dangerous binary views of uncertainty. Information technology offers a discipline for thinking rigorously and systematically about uncertainty. On one plane, it is a guide to judging which analytic tools can help in making decisions at various levels of uncertainty and which cannot. On a broader plane, our framework is a way to tackle the most challenging decisions that executives take to make, offering a more complete and sophisticated agreement of the uncertainty they face and its implications for strategy.

    This article is based on enquiry sponsored past McKinsey’s ongoing Strategy Theory Initiative (STI). The authors would similar to thank their STI colleagues for their significant contributions to this article.

    A version of this article appeared in the Nov–December 1997 event of
    Harvard Business Review.

    Determine Which Economic Principle is Illustrated by Each Scenario

    Source: https://hbr.org/1997/11/strategy-under-uncertainty

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