- The Strategy Paradox
- The contradiction of making a strategic commitment; when a business commits to a particular strategy, it maximizes its chance of success as well as its chance of failure (all or nothing).
- Strategic Commitment
- The dedication of a company’s resources to a particular strategy.
- Strategic Uncertainty
- The unpredictability of the future means it is impossible to know which strategy will be the most successful.
- Requisite Uncertainty
- An organizing principle to manage strategic uncertainty; the top of an organization’s hierarchy should manage strategic uncertainty and longer time horizons while the lower levels manage operational execution and shorter time horizons.
- Strategic Flexibility
- A corporate framework for managing strategic uncertainty through the creation of strategic options, comprised of these four phases:
- Anticipate – build scenarios of the future
- Formulate – create an optimal strategy for each of those scenarios
- Accumulate – determine which strategic options are required
- Operate – manage the portfolio of options; preserving, exercising and abandoning them when necessary
Pure vs Hybrid Strategies
Committing to an pure strategy carries a chance of great success or great failure.
- Lead by cost & efficiency, with low prices and good-enough products
- Cost Leadership – Streamline costs to offer low prices
- Operational Excellence – Offer hassle-free service and lowest prices possible
- Exploitation – Refine current procedures, like efficiency, production, execution, etc.
- Defender – Maintain a stable share of the market with cost leadership and operational excellence
- Lead with a great product, by doing innovation and customer research
- Product Differentiation – Make a great product
- Product Leadership – Offer products that push performance boundaries
- Customer Intimacy – Develop what specific customers want
- Exploration – Discover new possibilities, conduct research, vary product lines, take risks, and innovate
- Prospector – Locate and exploit new products and market opportunities
- Analyzer – Maintain stable market share while finding new products and market opportunities
Companies pursuing a hybrid strategy are making a risk/return trade-off – lower risk for lower return. However, hybrid strategies are not as profitable as pure strategies.
The Limits of Adaptability
Adaptability works only when an organization can match the pace of environmental changes. Very few organizations can, however. The market either goes too fast or too slow, resulting in a mismatch and potential for failure.
- If an organization is tuned to a slower environment, a fast change will overtake it
- Example of fast changes are technological advancements and new-market disruptive innovations
- If an organization is tuned to a faster environment, a slow change will mean it has leapt ahead of its consumers
- Examples of slow change are traditional consumer behaviors and low-end disruptive innovations
The Limits of Forecasting
It is impossible to predict the future accurately enough for strategic planning or adaptability. There are too many variables to calculate them all.
Time as an Organizing Principle
The longer the time horizon for a particular strategy, the greater the number of considered scenarios and the lower the certainty of any of them. Therefore, the time horizon is the most important dimension of any organizational structure, in terms of strategic uncertainty.
- U-Form Organization
- Unitary form; functionally/horizontally-organized; dividing an organization into functional units (e.g. marketing, finance, production, etc).
- M-Form Organizations
- Multidivisional form; business/vertically-organized; dividing an organization based on the critical element of an organization’s strategy (e.g. by markets, by regions, by distribution channels, etc).
- Requisite Organization (RO)
- An organizational theory from Elliott Jaques. All employees have a “boss” (the direct supervisor) and a “real boss” (the person from whom one can get a useful decision), which sometimes isn’t the same person. The real boss is always someone whose time horizon of responsibilities is incrementally greater than the employee’s. No matter how complex, all organizations have seven levels of hierarchy based on time horizon divisions.
An organization’s hierarchy should be differentiated by the degree of strategic uncertainty for which each is responsible, with the top addressing the most and the bottom addressing the least.
- Corporate leaders should be concerned with the long-term time horizons and strategic uncertainty
- Departmental leaders should be concerned with medium-term time horizons
- Functional managers should be concerned with short-term time horizons and tactical execution
The Role of the Board of Directors
While the board should not decide what the company’s strategy should be, it is uniquely positioned to determine how much exposure to risk and opportunity the company should have.
Making Choices vs Creating Options
One way to manage strategic uncertainty is to hedge the company’s strategy by creating real options – buying equity in a diverse portfolio of companies. Even if the diversification lowers the parent company’s overall performance, if the child company’s performance is above the parent company’s average cost of capital, than this diversification will create value.
- Unrelated Diversification
- Purchasing equity in another company to leverage the parent company’s control mechanisms and increase the child company’s performance
- Vertical Integration Diversification
- Purchasing equity in another company and facilitating supply-chain connections with one another.
- Related Diversification
- Purchasing equity in another company to share critical resources, from distribution channels to patents to brands.
- Strategic Diversification
- Purchasing equity in another company to lower the parent company’s strategic risks while increasing its strategic opportunities.
It is very difficult for individual leaders to carry out such plans. Doing this successfully requires a corporate office with an organizational framework to direct and guide the actions of the operating divisions.
A corporate framework for managing strategic uncertainty.
- Resource Constraints
These determine what can be spent. There are three: money, time, and people. Strategic Flexibility deals with two:
- Structural Constraints
These determine how those resources can be spent, keeping complexity manageable.
- Scope – the width of the plan, what it encompasses
- Scale – the enormity of the plan, how large it is
- Strategic Constraints
These define whom to spend the resources on, keeping the resources focused on the right things.
Creating Strategic Flexibility
Strategic flexibility is not the same as flexibility or adaptability, it is the ability to change strategies. This can be done through the following framework, starting with anticipate, then formulate, then accumulate, then operate, and back around to anticipate again.
Create multiple scenarios that cover possible futures over a relevant time horizon.
What are scenarios and what are they for?
- They are specific and coherent descriptions of different futures
- They each portray different and extreme conditions
- They group similar variables together so they are easier to handle
- They are credible and realistic
- They capture the range of opinions among an organization’s leaders
How do you create scenarios?
- Ask the right questions – such as long-term, strategic questions
- Identify the dimensions of uncertainty – such as the economy, government regulation, technology, etc.
- Determine the limits of uncertainty – find the appropriate boundaries for each dimension
- Determine the final scenario set – distill the dimensions into a reasonable, manageable set
- Determine the relative probabilities – prioritize each based on its probability
Determine the optimal strategy for each scenario, then define the strategy’s core and contingent elements at the corporate level while lower levels hedge and learn how to best achieve the targets set for them.
Board & Corporate
- Deals with: Strategic Uncertainty
- Aims for: Strategic Flexibility
- Answers: “What could threaten our survival?”
- Determine which strategic elements are core and which are contingent
- Profitable to all scenarios; build these into the company
- Profitable in just some scenarios; seek options to cover these
- Deals with: a mixture of Strategic Uncertainty and Commitment
- Aims for: hedging the downside while committing to a strategy
- Answers: “What could undermine our strategy?”
- Can still use scenarios, but cannot really create strategic options
- Deals with: Commitment
- Aims for: learning how to achieve its targets
- Answers: “What could derail our project?”
- Handles tactical problems
Gather strategic options based on the contingent elements determined from the Formulate phase. Options can be obtained through acquisitions, joint ventures, and partial ownership deals.
- Outright purchase of another company
- Pros: total control of the option, great for exercising the option
- Cons: high cost, moderate commitment level, difficult to abandon
- Formed when two or more organizations create a new company together
- Pros: allows exploration of a new market, low cost, low commitment level
- Cons: competition with co-founders in a learning race for the new market, potentially dysfunctional relationship with co-founders
- Taking partial equity stake in another company
- Pros: allows evaluation of an existing market, low cost, low commitment level
- Cons: difficult to gauge how much ownership is best (too little means exercise difficulty, too much means abandonment difficulty)
Evaluate each option and determine when to preserve, exercise, or abandon each one.
- Maintain the target company in the portfolio for future use or abandonment
- Inject cash if the target company is operating at a loss, though this raises the cost of preservation
- Manage the target company as an unrelated division; too much autonomy means unpredictable option value, too much management means it cannot grow naturally
- Integrate the target company in to the parent company and a new strategy using on of these methods:
Business units find the target company and integrate it, with the approval of the corporate office
Corporate office guides the business units to integrate and operate the target company
Business unit and corporate leaders work together to integrate and operate the target company
- Sell or divest the target company if it’s an option no longer valuable to the parent company
- Though it is typically seen as a failure, abandoning an option is much cheaper than exercising a poor option
- A strategic option’s value is determined by the value the organization places on a particular risk/return profile
- Human judgment of an option’s value is better than using a financial framework