Great strategies add risk. This is counter to conventional and intuitive logic. Good strategy surely puts organisations at less risk via the creation of better competitive positions that over time generate positive economic returns. This is true to the extent that the future within which the strategy is planned to compete manifests with sufficient congruency. Herein lays the strategy paradox. Strategy requires companies to commit resources to a certain set of actions within the bounds of an uncertain future. The expected future is not an inevitable reality but rather a range of potential outcomes intertwined with randomness and probability. The paradox sets up uncertainty (Future) and commitment (Strategy) as two explicit constructs that must be managed simultaneously and successfully. This paradox and its implications for strategy making and management were made explicit by Michael Raynor in his book entitled The Strategy Paradox. Within the context of business growth the paradox offers interesting insights in how to think, plan and structure for growth.
One of the key insights that flows from the paradox is that strategy is as much about crafting positions as it is about managing uncertainty. Strategy thus becomes about making bold commitments to definitive positions (requirement for stellar performance) and mitigating the risk of future states that nullify your strategy’s impact. The wrong commitments executed exceptionally well are dangerous in unfriendly future realities. Raynor argues that this is not a theoretical but rather a general empirical condition that requires explicit management.
On the face of it there seems two potential ways to deal with the paradox –
- Become more adaptive
- Become better at predicting the future
Raynor argues that neither of these are realistic or pragmatic responses. His view is that adaptability is far less useful than expected. Competitive reality produces multiple rates of change requiring organisations to adapt at different rates at the same time. This is beyond the realm of most organisation abilities. Trying to time adaptability is also very challenging. You either end up ahead of or behind the curve, both of which have negative consequences. On predictability he argues that doing so at the level of detail required to be strategically effective is an illusion. The future is a set of potential outcomes underpinned by randomness. Get the initial position of a potential scenario wrong or assign incorrect probabilities or fail to notice potential exogenous shocks and its value is debased from the start.
The proposed solution is based on an organisational principle called requisite uncertainty supported by a tool set or framework called strategic flexibility.
Requisite uncertainty proposes that uncertainty and commitment need to be managed separately. This is achieved by making different levels of the organisation responsible for each.
- Boards Role – Is not about strategy making or selection but rather about understanding and managing uncertainty i.e. what risks does the company face and what risks is it willing to accept, hedge or avoid. The key question they need to understand is what event or set of would threaten our survival
- CEO – Core responsibility is the creation of a portfolio of real strategy options that can be deployed given how the future starts to play out. This requires an understanding of what the risk variables are, how they pan into potential scenarios and what strategies could effectively deal with the resultant realities. The core question is which core strategy elements are consistent within all potential scenarios
- Divisions – Create and manage strategy (commitments). Their core question is what would derail our strategy projects
Creating strategic flexibility, the ability to change strategies as opposed to being adaptable within an existing strategy, via the creation of real options is aided by a set of managed constraints. He argues there are three levels of constraints:
- Resource Constraints – establish time and investment levels that a division can use to constrain there strategy. This stops commitments being made that take too long or cost too much to deliver results
- Structural Constraints – Restrain the scope of operation and size to which a division can grow
- Strategic Constraints – Manage where resources need to be allocated and what needs to be monitored i.e. key customer need states or recognised risks elements
Lastly, the creation of strategic options takes place via a four step process – Anticipating, formulating, operating and accumulating.
While fascinating, my observation (as confirmed by Uncle Grey) is that boards are increasingly concerned with governance issues rather than management of strategic uncertainty. The requisite uncertainty concept is exceptionally powerful but does require exceptional leadership and strategic competency development. Combining options theory with strategy development and management, while not new, is equally insightful but as above difficult to do. Most management teams are schooled in the management of revenues, costs, earnings and capital expenditure and not volatility and options management. That said, Timothy Luehrman points out that management teams unwittingly commit to a set of nested options every time they derive a new strategy. Deciding to develop a new product presents a bunch of options – Licence rights or market entry (Y/N), expand production capacity (Y/N), direct or indirect channel development etc. Exercising each option creates a new set of commitments, uncertainties and strategy options. Understanding upfront all potential options, their value and need to execute time line will make the art of strategy development even more valuable.