20 March 2019

Adopting the right strategy – under uncertainty

With so much Brexit uncertainty, it is important that companies plan for all eventualities, as uncertainty punishes those who do not plan.

A framework for determining the level of uncertainty surrounding strategic decisions and for tailoring a strategy to that uncertainty can be found in ‘Strategy under Uncertainty', an article in the Harvard Business review, published by Hugh Courtney, Patrick Viguerie and Jane Kitkland. They identified four prime levels of uncertainty.

Four levels of uncertainty
Available strategically relevant information tends to fall into two categories:

• 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.
• If the right analyses are performed, many factors that are currently unknown to a company's management are in fact knowable.

The uncertainty that remains after the best possible analysis has been undertaken is referred to as residual uncertainty. The residual uncertainty facing most strategic-decision makers can fall into one of four broad levels.

Level one: A clear enough future
The residual uncertainty is irrelevant to making strategic decisions at level one, so managers can develop a single forecast that is a sufficiently precise basis for their strategies. To help generate this usefully precise prediction of the future, managers can use the standard strategy tool kit: market research, analyses of competitors' costs and capacity, value chain analysis, Michael Porter's five forces framework, and so on. A discounted cashflow model that incorporates those predictions can then be used to determine the value of alternative strategies.

In predictable business environments, most companies are 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 a series of no-regret moves. Where do you fit here? It does not have to be boring and it can be a disrupting change that gains you competitive advantage.

Level two: Alternative futures
The future can be described as one of a few discrete scenarios at level two. Analysis can't identify which outcome will actually come to pass, though it may help establish probabilities. Most important, some, if not all, elements of the strategy would change if the outcome were predictable. In classic level two situations, the possible outcomes are discrete and clear but hard to predict.

Understanding of how the key residual uncertainties might play out. Each scenario may require a different valuation model. Getting information that helps establish the relative probabilities of the alternative outcomes should be a high priority.

After establishing an appropriate valuation model for and determining the probability of each possible outcome, the risks and returns of alternative strategies can be evaluated with a classic decision analysis framework. Particular attention should be paid to the likely paths the industry might take to reach the alternative futures, so that the company can determine which possible trigger points to monitor closely.

Level three: A range of futures
A range of potential futures can be identified at this level with a limited number of key variables defining that range. As in level two, some, and possibly all, elements of the strategy would change if the outcome were predictable. Companies in emerging industries or entering new geographic markets often face level three uncertainties.

The analysis in level three is similar to that in level two: a set of scenarios describing alternative future outcomes must be identified, and analysis should focus on the trigger events indicating that the market is moving toward one or another scenario. Developing a meaningful set of scenarios, however, is less straightforward in level three.

Scenarios that describe the extreme points in the range of possible outcomes are often relatively easy to develop but rarely provide much concrete guidance for current strategic decisions. Since there are no other natural discrete scenarios in level three, deciding which possible outcomes should be fully developed into alternative scenarios is a real art. But there are a few general rules:

• Develop only a limited number of alternative scenarios - the complexity of juggling more than four or five tends to hinder decision making.
• Avoid developing redundant scenarios that have no unique implications for strategic decision making.
• Develop a set of scenarios that collectively account for the probable range of future outcomes and not necessarily the entire possible range. Establishing the range of scenarios should allow managers to decide how robust their strategies are, to identify likely winners and losers, and to determine, at least roughly, the risk of following status quo strategies.

Level four: True ambiguity
A number of dimensions of uncertainty interact to create an environment that is virtually impossible to predict at level four. In contrast to level three situations, it is impossible to identify a range of potential outcomes, let alone scenarios within a range. It might not even be possible to identify, much less predict, all the relevant variables that will define the future.
Level four situations are quite rare, and they tend to migrate toward one of the others over time. Nevertheless, they do exist: a telecommunications company deciding where and how to compete in the emerging consumer multimedia market for example. The company will confront a number of uncertainties concerning technology, demand, and relations between hardware and content providers. All of these uncertainties may interact in ways so unpredictable that no plausible range of scenarios can be identified. Brexit is now a factor here for some?

Situation analysis at level four is highly qualitative. It is important to avoid the urge to throw up your hands and act purely on instinct. Instead, managers need to catalogue systematically what they know and what it is possible to know. Even If it is impossible to develop a meaningful set of probable, or even possible, outcomes, managers can gain a valuable strategic perspective.

A company can assume a number of strategic postures vis-à-vis uncertainty, and a number of actions of actions can be used to implement that strategy.

STRATEGIC POSTURE Define the intent relative to current and future state of the industry.

SHAPING Seek a new structure for their industry of their own choice. Very disruptive and opportunistic online B2C print is an example here.

ADAPTING They take things as they are and adapt accordingly or react accordingly.

RESERVING THE RIGHT TO PLAY Do things incrementally in the best possible way. Through superior information, cost structures or relations between customers and suppliers that allows the company to wait until the environment becomes less uncertain before formulating a strategy.

Again, where do you feel you sit in all of this - if any?

A PORTFOLIO OF ACTIONS Big bets, options, and no-regrets moves. A posture is not a complete strategy; it clarifies strategic intent but not the actions required to fulfil that intent. Three types of moves are especially relevant to implementing strategy under conditions of uncertainty.

BIG BETS Large commitments such as major capital investments or acquisitions that will produce large pay-offs in some scenarios and large losses in others. Not surprisingly, shaping strategies usually involve big bets; adapting and reserving the right to play, do not.

Options are designed to secure the big pay-offs of the best case scenarios while minimising losses in the worst case ones; classic examples include conducting pilot trials before the full scale introduction of a new product, entering into limited joint ventures for distribution to minimise the risk of breaking into new markets, and licensing an alternative technology in case it proves to be superior to a current alternative.

Companies reserving the right to play rely heavily on options, though shapers use them as well, either to shape an emerging but uncertain market as an early mover or to hedge big bets.

Our sector is undergoing rapid structural and strategic change, change to supply and demand, changes to the supply chain and accelerated pace of technology integration and convergence playing havoc or providing opportunity. As ever it depends on where you sit or what's your perspective is.

Some see a clear enough future, some a combination of alternate futures and a range of futures. Many don't want to see anything but ambiguity and these if they don't adapt and change will suffer the most.

68% of respondents answered yes to this question: ‘Do you undertake any future risk scenario planning when looking at the benefits of investment?'

Decision making in an environment of perpetual uncertainty
Uncertainty punishes those who do not plan effectively, or create enough flexibility and do not act decisively to make positive change for the business. As a sector we are used to uncertainty and it is worth looking at how other sectors manage levels of uncertainty around decision making.

Any capital investment decision is based on the benefit it provides in the future both perceived and tangible. Will the benefit be large enough to justify it? Getting it right means sustainability, growth, better margins and business momentum. Getting it wrong can mean enduring more difficult times or compromising your business. In an industry defined by much strategic and structural change and new technology developments, getting it right is more complex and more perturbing and more time consuming.

An academic's viewpoint
Paul Saffo's rules for effective forecasting involve the laws of logic:

• Know when not to make a forecast and take on-board the uncertainties that prevail at the time. There are many types of uncertainty and its worth plotting them and defining their impact and relative importance to your decision making outcomes.
• What are the sources of uncertainty, technology changes, customers, staff retention etc?
• What can be plotted with some certainty?
• What events might happen or are more likely to occur?
• Map the impact.
• What options and responses can we activate if we need to or need to undertake as part of the change?
• Factors that might affect you will have similarities with others but some will be unique to you.
• Uncertainty is what we have become used to, master it.

Overnight successes come out of predicting failure. Change does not usually follow a straight line. Saffo says it follows an S curve. Earlier on in the S curve of events change starts slowly and incrementally then explodes and tapers off again. But if you don't manage and pay attention all away along the timescale, you will get a surprise!

LOOK BACK TWICE AS FAR AS FORWARD The change you have lived through in the last ten years is a predictor of what you are likely to experience in the next five. The cycle of change has been condensed over the past two years as economic pressures have bitten.

HUNT FOR THE EARLY SYMPTOM OR LEADING INDICATOR An observation made by William Gibson in ‘The Science of Science Fiction' stated that the "future is already here, it's just unevenly distributed". Some people seem to have the knack of identifying the leading indicator. But there is a lot of good observational activity and information you can tap into. Vendors have market analysis and market information in abundance, just ask their marketing personnel directly.

BE INDIFFERENT Don't confuse your desire for a particular outcome with its likelihood. That is also a good reason to get impartial and independent and take objective advice.

TELL A STORY OR DRAW A ROUTE MAP Trying to package your insights into a story or scenario also helps reveal gaps, identify risks, and the opportunities present in the events you are trying to understand. Don't forget to look at the Wildcard event also. Big ‘what if' questions are something we have learned from recent events, especially when we see blue chip companies going Boom!

PROVE YOURSELF WRONG The essential wisdom of the scientist is understand and resist the natural human tendencies to believe. Be careful not to rely on a single element of strong information. Look for lots of pieces of weak information that collectively reinforce your insights. Your search for strong information should be for that one piece of evidence that proves you wrong. Look for the one thing that will make you look stupid if someone else brings it up.

Uncertainty or lack of perfect knowledge manifests itself in many ways:

• Who do I trust?
• What is the range of uncertain issues - customers, revenues, appropriate technology etc?
• Where can I find the appropriate information to support my own sources and information network?
• How have others faired when taking and making such a decision?
• Have we mapped out the full extent of the journey and outcomes that we might face?

You can learn a lot from others experience and it is worth asking on a wider basis and also getting more information from your supplier, not just examples on the European mainland. But remember one size does not fit all and you will have some unique aspects to your particular business model and markets.

To read more on these topics download our BPIF Investment Decision Making Report