DSI Newsletter

“Strategy development under uncertainty” is a new column focusing on highlighting some of the key frameworks and tools used to develop winning strategies under uncertainty. This piece will set the stage for following articles that will provide more detail on specific steps and considerations for generating, valuing, selecting and monitoring strategic options.

Background

Every manager and consultant knows that the most challenging part about strategy development is coming up with creative and relevant strategic options. We are not talking about the incremental and tactical moves, but rather the type of strategic options that will result in competitive advantage and drive sustainable value creation. While almost anyone with business training and access to information can perform some kind of strategic analysis, very few are actually able to transform that analysis into a set of truly winning strategies.

With the economy picking up again, and CEOs back into growth mode, the question of how to develop winning strategic options is extremely relevant once again. Recent books urge managers to achieve “double digit growth”, “grow beyond the core” or “grow when their markets don’t”. However, they offer limited help in improving the companies’ ability to advance their strategic management capabilities to continually develop winning strategic options (to be fair, this is not necessarily their intended objective). We are not talking about the incremental and tactical moves, but rather the type of innovative strategic options that will result in competitive advantage and drive sustainable value creation.

At DSI, we believe that developing winning strategic options is a result of a process(see Figure 1). First, there is the insight provided by the development of multiple relevant and plausible scenarios. Second, there is the guidance provided by the construction of a strategic vision. And third, there is the discipline provided by a structured and comprehensive approach to generate, value, select and monitor strategic options. This article focuses on this latter challenge.

A Structured Approach

Strategic planning has received a lot of bad press in recent years. With rising levels of complexity and uncertainty, strategies are often implemented with important deviations from their original plans. This has motivated many authors and managers to assert that strategy is more “emerging” than “deliberate” and that strategic planning has lost its meaning.^[1] The fact that many growth options are a result of M&A (mergers and acquisitions) moves, which are by nature opportunistic, only adds to this trend of thought.

At DSI, we believe that planning (with a twist!) is still of the utmost importance. By embracing uncertainty in the strategic planning process, firms are able to discover risks and opportunities and prepare for them. When the timing is right or “emerging,” those companies that have envisioned the future and planned in advance will be the ones able to preempt competition and reap the benefits of foresight. Developing strategic options is just another part of a structured and comprehensive planning approach.^[2]

The development of strategic options should come after the firm’s strategic vision is defined (see again Figure 1). Developing strategic options without a clear strategic vision is like setting out to sea without a port of destination. The merits of a good and inspiring vision have been well documented in recent years.^[3] However, we often need more detail than just a catchy phrase to guide the development of strategic options. A good strategic vision needs to state the objective and intent of the business, the market, geographical and product scope, and the required capabilities (and gaps) for achieving those objectives. It also needs to provide guidance on which businesses it wants to commit to and on which it wants to remain flexible on.

Once the vision is set, developing winning strategic options requires a four stage approach (see Figure 2). In Stage 1, we generate a set of initiatives that will allow us to achieve the vision. In Stage 2, we value the initiatives individually and as part of a portfolio. In Stage 3, we select the optimum portfolio of initiatives. And in Stage 4, we start the external and internal monitoring process to execute the initiatives when the right conditions emerge. We briefly consider each stage.

Stage 1 is all about expansive thinking. At this point, we are interested in generating as many potential initiatives as possible. To this end, we combine techniques for creative thinking (focus on process), tools for mapping prospective strategic moves (focus on process as well as content) and driving questions from the scenarios, competitive analysis and strategic vision (focus on content).

There are numerous excellent “how to” guides to encourage “out of the box” idea development.^[4] They are especially important for creating options for the future and coming up with different ways of executing and structuring the more obvious moves. The important thing is not to be bound by the current condition of the firm or “frames” about the industry. (The eariler process of scenario planning should also have helped expand the thinking of managers).

There are several “templates” we use to guide managers through the initiative generation process. These templates serve the purpose of reminding managers of the different strategic levers and potential moves at their disposal. They are often linked to the frameworks used during the external analysis phase of the strategic process (e.g. segmentation maps, value innovation, disruptive innovation, knowledge maps). Some of these tools include morphological boxes, hub and spoke and KSF gapping templates.^[5]

Finally, some of the driving questions we use in the generation process include:

Throughout the generation process, we need to make sure there is a right balance of short- and long-term actions, incremental and bold moves and robust (applicable in all scenarios) and bet-type initiatives (applicable in only one or two scenarios). We also need to make sure that we have captured enough information on the initiatives to go forward in the process (e.g. alternatives for execution - build, buy or partner, payback periods, relevant scenarios and type of uncertainty – private or market-based). After we have generated a comprehensive number of initiatives, we are ready to value the most promising of them and to build alternative portfolios.

Stage 2 signals the start of the convergent process; it is about analyzing and combining initiatives to achieve the strategic vision, create sustainable advantage and maximize value creation.

Given the long list of initiatives that often results from Stage 1, we sometimes start Stage 2 by pre-screening the list (e.g. by their attractiveness, competitiveness and/or relatedness to the business) to come up with a manageable list for a detailed analysis. At this stage, we start talking about options because we have the right but not the obligation to use the initiatives identified at the previous stage.

The full analysis of strategic options will typically include a financial (what is the full value of the option – DCF plus option value - and required level of investments?); strategic (what is the fit with the strategic vision? Does it build any of the required capabilities?); risk (what risks surround the options in light of the different scenarios?) and organizational analyses (how well does the option fit with the firm’s culture?).

After we have conducted a detailed individual analysis of the options, we move into building portfolios of options, which is one of the main techniques for managing uncertainty. Since most scenarios are outside the control of individual firms, portfolios are the best way to protect against and profit from the uncertainty resulting from a diverse set of plausible futures. Usually it is necessary to search for some additional options that will either reduce the overall risk or add some upside without significantly compromising the portfolio (e.g. a bet on one of the scenarios). After we have developed and analyzed alternative portfolios, we are ready to select the “optimum” portfolio for the firm.

Stage 3 is about decision-making. It is also the stage at which senior managers are involved the most since it requires a broad perspective of the business and the ability to weigh between competing objectives.

The ranking performed in the last stage at the individual level is now done at the portfolio level. Techniques like Multi Attribute Utility (MAU) models are used to rank alternative portfolios in terms of their financial and strategic contributions, risk profile and organizational fit. While it is possible to have a clear winning portfolio during the scoring exercise, more often than not, there are alternatives with real trade-offs that need to be discussed by senior management before committing to any one course of action. This could take more than one round of discussions, especially if some of the portfolios can be improved by addressing some of top management’s concerns (e.g. switching from strong to flexible commitments, transferring some of the risk).

After we have selected the “optimum” portfolio, we are ready to start with its real-time monitoring.

Stage 4 combines expansive and convergent activities. It is expansive in that it scans the environment to identify changes that would indicate the emergence of a particular scenario. It is convergent in that it uses that information to trigger the execution of particular options in the portfolio and then monitor their results.

Before stage 4 can begin, the portfolio of options usually needs to be approved and funding secured for the options to become projects. Those options that are robust across scenarios should get funded to start as soon as possible, while the fragile options (those that are more valuable in specific scenarios) should get funded to start as small learning projects or to actively wait until some of the uncertainties are cleared.

Options monitoring is done at two levels. The first is done as part of the external scanning of the environment. The objective is twofold, to scan the periphery for subtle changes in the marketplace and to monitor signposts and events identified as part of the scenario development process. The second is done as part of the internal management and control of the business. The objective is again twofold, to monitor the progress of each strategic project and to follow-up on the accomplishment of the overall vision.

Since strategy development is an on-going process, monitoring provides another important function in the cycle; it helps managers understand when it is time to start the process all over again by developing a new set of fresh scenarios for the business.

Principles for Strategic Options’ Development

Before ending this article, we wanted to share some of the principles we take into consideration at DSI when developing strategic options for our clients. While we never go into the process with a prescriptive recipe on what strategic options are best, we do have some guiding principles:

· Be “deliberate” to prepare for the “emerging”:. The fact that strategy emerges over time does not eliminate the need to prepare and plan for the future. To the contrary, it is even more important to do so. Like Yogi Berra once said: “When you come to a fork in the road, take it.” Preparing for a wide range of futures, and developing options to cope with them, is the best way to react fast enough when the fork appears.

Global retailers provide an illustrative example. The Indian market is the second most attractive emerging retail market in the world.^[6] However, global retailers have not been able to tap into the huge Indian market because of regulatory constraints. The preferred option to date has been to ignore India until the opportunity “emerges”. An alternative option is the one being considered by some of the heavy-weights like Wal-Mart and Carrefour. That is to work around current regulations (using licensing arrangements and joint ventures) to learn about the market and plan for a full-scale entry in advance of an ease in the restrictions.

· Take a portfolio approach:. The future is more uncertain and complex than ever. Like the savvy investor who knows that having a well-diversified portfolio is the greatest protection against random risk, firms need to take the same view to mitigate the risks and reap the benefits of an uncertain future. While there is much debate about the right level of diversification in a firm’s portfolio, it seems as if having a wide view of the business (and thus developing options that would result in some kind of related diversification) makes sense in a world where industry boundaries change overnight and life cycles are shorter than they have ever been.

Johnson & Johnson (J&J) provides an illustrative example. J&J is “the world's most comprehensive and broadly-based manufacturer of health care products as well as a provider of related services for the consumer, pharmaceutical and professional markets. Johnson & Johnson has more than 200 operating companies, which manufacture and market thousands of products in hundreds of categories...”^[7] However, J&J does not stop at having a broad portfolio of categories and products. It also actively manages that portfolio to make sure that it strengthens its position in the most attractive segments of the market (e.g. the recent acquisition of Guidant to strengthen its position in heart and cardiovascular disease therapies) and it exits those segments that are no longer attractive and/or where they cannot win (e.g. the divestiture of their non-wovens business).

· Move beyond three horizons and combine them with scenarios:. Planning for three horizons (to defend and grow the current business, to build new emerging business and to fund options on the future) is a good management practice.^[8] However, these horizons might be very different depending on which scenario plays out in the future. As a result, firms need to expand their “frames” to make sure that they develop options not just for three horizons, but for multiple combinations that result from the scenario planning process.

Microsoft provides an illustrative example. A typical Horizon 2 move for this company would be growing its presence and penetration in the Chinese market. However, the available and winning options are really tied to the resulting scenario that plays out in this country. Under one scenario, IP is enforced and China becomes a free-for-all market for local and multinational players. In an alternative scenario, rogue rules and regulations are set in place favoring local companies to the detriment of multinational players. Depending on which future plays out, there are timing and strategy considerations on how to conduct business in China. The key is understanding the plausible futures before labeling the horizons and choosing the options for each one.

· Combine "baby steps" with bold moves:. Flexibility is important but it always comes at a price. Many managers believe that the key output for scenario planning is identifying the robust strategies across a set of futures. This is not exactly true. While robust strategies are important (especially since they offer low volatility of earnings), they need to be combined with fragile strategies and some “calculated risks” (i.e. bets) to optimize the long-term return of the business^[9]. A portfolio of robust strategies is almost always a sub-optimal alternative in an efficient frontier analysis. The reason for this is that it concedes the upside associated with bet-type initiatives that could add significant value for a manageable level of additional risk. Furthermore, in today’s ever-changing world, bets are necessary to maintain competitive position and avoid being swept by new and old players.

The US telecommunications’ companies provide an illustrative example. According to some recent reports^[10], companies have been pursuing two alternative strategies for growth. One strategy has been to “buy growth”, followed by SBC (US$ 16 billion acquisition of AT&T) and Qwest communications. Another strategy has been to “grow from within” by developing state-of-the-art wireless and broadband networks, followed by BellSouth and until recently Verizon. The latter strategy, while less bold, appears to have greater flexibility given the uncertainties surrounding wireless technologies, optical networking, regulation and profitability in the enterprise segment. However, the latter strategy also limits the possibility of growth in the corporate market given the relatively high switching costs. As a result of the above, Verizon has decided to combine its robust strategy of growing its own wireless and broadband network with the bet of acquiring MCI. While there is no guarantee that the deal will add value to Verizon, the decision might still be valid given the risk-return it offered at the time the decision was made.

Incremental strategies and options seldom provide large payoffs. Therefore, incremental steps need to be combined with bold steps to achieve optimum results; and vice versa. In a world where M&A’s are again the preferred growth strategy for large companies in the US, managers need to be reminded about some of the facts. More than 50% of all M&A’s destroy value in the US^[11] and large initiatives have less than half the probability of success of small ones. As a result, combining the bold with the les audacious is the way to go.

Procter & Gamble (P&G) provides an illustrative example. After years of taking reasonably small steps to revamp its innovation engine (e.g. Crest “Spinbrush”), strengthen its core businesses and move into close adjacencies (e.g. purchasing Clairol), the Cincinnati consumer goods company was ready to take a bold move to reduce pressure from retailers (e.g. Wal-Mart) and distance itself from competition. Earlier this year, P&G purchased Gillette for an estimated US$ 57 billion in stock, launching the company to the number 1 spot in the consumer goods industry. While the jury is still out on the results of the purchase, the odds are much better than some of the deals made during the boom M&A years of the 1990s.

Takeaway

Developing winning strategic options is at the core of any strategy process. By combining the insights of multiple and relevant scenarios, the guidance of a detailed strategic vision and the discipline of a structured approach to options development, firms are better positioned to mitigate the risks and reap the benefits of uncertainty. In following pieces we will explore in more detail the tools and considerations for each of the four options development stages; namely, options generation, options valuation, options selection and options monitoring.

If you would like to explore this subject further, please refer to our website (www.thinkdsi.com) or contact us at: sichel@thinkdsi.com or (610) 717-1000.

^[1] See for example Henry Mintzberg’s The Rise and Fall of Strategic Planning. (New York: Free Press, 1994) and Mintzberg et al’s Strategy Safari: A Guided Tour Through the Wilds of Strategic Management (New York: Free Press, 1998).

^[2] For a full discussion on DSI’s strategic planning process under uncertainty, see Paul J.H. Schoemaker’s Profiting from Uncertainty: Strategies for Succeeding No Matter What the Future Brings (New York: Free Press, 2002)

^[3] See for example Jerry I. Porras and James C. Collins Built to Last: Successful Habits of Visionary Companies (New York: HarperCollins, 1994).

^[4] See for example Edward de Bono’s Lateral Thinking: Creativity Step by Step (Perennial, 1973).

^[5] See for example Chris Zook’s Beyond the Core: Expand your Market without Abandoning your Roots (Boston: Harvard Business School Press, 2004).

^[6] Based on AT Kearney’s Global Retail study (2004). This study takes into account such variables as: market size, long-term potential, penetration of global players, retailer’s concentration, among others.

^[7] Quoted from www.jnj.com

^[8] See Mehrdad Baghai et al’s The Alchemy of Growth: Practical Insights for Building the Enduring Enterprise (Cambridge: Perseus Publishing, 1999).

^[9] Generally speaking and independent of a firm’s risk-attitude, robust strategies call for strong commitments while fragile strategies (not robust across scenarios) call for flexible commitments with an options approach. Bets are made in those situations in which strong commitments are worthwhile even if an option’s approach cannot be worked into the initiative.

^[10] Business Week. Telecom: to buy or to build? February 21, 2005 edition, 38.

^[11] According to BusinessWeek, 61% of them destroyed value to shareholders of the buying company between 2002 and 2004. (BusinessWeek, Have dealmakers wised up? February 21, 2005 edition, 36-37.)