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Managing amid uncertainty dtt

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Managing amid uncertainty dtt

  1. 1. Deloitte Research A study by Deloitte Consulting and Deloitte & Touche Managing Amid UNCERTAINTY New thinking on how to win in a volatile world
  2. 2. 20 What is the best way to cope with an unpredictable economic cycle? That depends – on the length and depth of recessionsandthestrengthandbreadthof recovery. Theproblemisthatthesecritical variables are unknown and unknowable. What is needed is a new way to manage that embraces uncertainty rather than largelyignoringit.
  3. 3. Introduction ................................................................... 2 TheFutilityofForecasting ................................................ 2 ApplyingStrategicFlexibility............................................ 4 Conclusion .................................................................... 12 EndNotes...................................................................... 13 AboutDeloitteResearch................................................. 14 AboutDeloitteConsultingandDeloitte&Touche.............. 15 CONTENTS
  4. 4. 2 The Futility of Forecasting As the last decade drew to a close, prominent economists were claimingthe“endofthebusinesscycle”andpermanenteconomic growth.1 After a decade of expansion in the US,such optimism appeared justified. As late as July 2000, consensus forecasts envisioned 3.2% growth for the US economy in 2001.2 As 2000 wore on,these forecasts grew ever more pessimistic, with some callingforrecessioninperhapsthesecondorthirdquarterof2001, but recovery was typically predicted for late 2001. By the last quarter of 2001, the US National Bureau of Economic Research haddecidedthattheeconomyhadactuallybeeninrecessionsince March2001. Asoflate2001,recoverywaspredictedformid-2002, with the proviso that the threat of continued terrorism could be contained.So much for the end of the business cycle. This phenomenon of constantly revised and ever-inaccurate forecasts is hardly new. But despite the dismal track record, we can’t shake loose our desire to forecast – primarily because strategy-building seems to demand it.Companies must ramp up or mothball production capacity, launch or shelve marketing initiatives,expand or contract their sales forces,and accelerate or idle their product development pipelines. Most executives seek to base these decisions on projections of what lies over the horizon. Suchforesighthasalwaysbeenbeyondreach,andthefutility of prediction has long been an open secret. Faced with the watershed events of September 11,2001,many are now voicing that skepticism and have become convinced that forecasting the future is a fruitless endeavor. The Economist recently noted that, “economic forecasting, always speculative, is now close to impossible”. This abandonment of our always tenuous predictive powers has even permeated corporate budgeting cycles. Dick Kovacevich, CEO of Wells Fargo & Co., said it well to his board: “Whatever budget we come up with is almost meaningless.”3 Introduction Traditional approaches to strategic planning rely for their success on accurate predictions of the future. But the nature of the uncertainty that imbues almost every aspect of today’s business environmenthasmadepredictionandevenforecastingessentially useless. And since many significant but unforeseen threats and opportunities crop up faster than firms can respond to them, neither can executives rely on“agility”as a mechanism for coping withuncertainty.Consequently,today’scompetitiveenvironment demands a new approach to strategic planning. This report presents just such a framework – Strategic Flexibility. Strategic Flexibility builds upon the established practices of scenario-based planning and strategy formulation,but combines them with insights drawn from the emerging field of real options to create something entirely new. The result is an approach to strategicplanningandstrategyimplementationthatisabsolutely indispensable to today’s global enterprises. Andsoalthoughitistruethatuncertaintypermeatesourlives, this fact need not paralyze informed action.Companies that are stategicallyflexiblenotonlycopewithuncertainty,butalsoexploit it.
  5. 5. DeloitteResearch–ManagingAmidUncertainty 3 What this suggests is that when strategies have failed – from international expansion plans to growth initiatives – they have done so not necessarily because they were bad strategies,but in alllikelihoodbecauseinimplementingthosestrategiesmanagers ran afoul of unanticipated events, such as slower-than-expected trade liberalization or economies thrown into recession.It is not ourstrategicthinkingthatfailsus,perse,butourcontinuedreliance on our inability to predict the future. Undertheseconditions,therisksinvolvedinbuildingstrategy on inevitably inaccurate predictions stand out in sharp relief. For example,consider two firms formulating their strategies in the teeth of a recession. The first firm – call it Optimist Inc. – predicates its strategy on a short, shallow recession and so minimizesitsrestructuringefforts,investsasheavilyaspossiblein new product development, and keeps advertising spending relatively high.This is a strategy of staying visible to consumers, ready to satisfy their soon-to-be-rekindled demand,and creating shareholder value through growth. Contrastthiswithasecondfirm–PessimistCo.–thatforesees aJapan-stylerecessionconsistingofadecadeormoreofsluggish growth in the overall economy, marked by slow or shrinking international trade and lower productivity. This sort of forecast demands much more severe cost cutting efforts and a focus on free cash flow in order to reward shareholders. If each of these firms pursues its prediction-based strategy, one of them is going to be caught out.In the event of a relatively short recession,Optimist Inc.will be well positioned for renewed expansion, while Pessimist Co. will incur large opportunity costs in forgone growth, potentially be shut out of future markets altogether,andconsequentlyforcedintobankruptcyorsoldtoits faster-growing competitors. Conversely, should the recession prove long or especially painful,PessimistCo.willhaveguessedright.OptimistInc.,however, will no longer be seen as having implemented a bold growth strategy.Instead,itwillhavebeenprofligatewithscarceresources that should have,in hindsight,been husbanded more carefully. Such a tale is not merely a Kipling-esque just-so story;there are real-life examples of companies relying on opposite assumptions when preparing for the future. For example,Airbus, the European aircraft maker, decided to bet that the downturn will be short, declining to lay off any workers at all so as not to jeopardize its ability to respond to the upturn. In contrast,its US- based rival Boeing announced plans to lay off tens of thousands of workers based on its view that demand for jetliners will remain depressed for a long time to come.4 In either case, someone wins and someone loses. But the winner is not the better strategist, or even the better predictor. The winner is simply lucky. There has to be a better way.
  6. 6. 4 ANTICIPATEANTICIPATE Each of these shapes constitutes not a prediction of how the economywillrecover–forthatwouldsimplyreplaceconventional strategy’s single inaccurate prediction with four inaccurate ones. Rather, each one is a form of boundary marker, and collectively the scenarios serve to limn the future,rather than predict it. Inotherwords,asetofscenariosmarksouta“possibilityspace”, with detailed scenarios serving as buoys in uncertain and potentially turbulent waters. Carving out this possibility space servesbothtobroadenourhorizons,allowingustothinkcreatively andexpansivelyaboutwhatmighthappen,whileatthesametime defining a finite set of possible futures within which a company might have to operate. FIGURE 1. THE STRATEGIC FLEXIBILITY FRAMEWORK SOURCE:DELOITTE CONSULTING ANALYSIS FORMULATE ACCUMULATE ANTICIPATE FORMULATE ACCUMULATE ANTICIPATE s Identify drivers of change s Define the range of possible futures s Develop scenarios s Develop an optimal strategy for each scenario s Compare optimal strategies to define“core”and“contingent” elements s Acquire those elements needed to implement the core strategies s Take options on elements needed for contingent strategies OPERATEOPERATE s Execute the core strategy s Monitor the environment s Exercise or abandon options as appropriate Applying Strategic Flexibility A premise of our approach to coping with the current environment is that it is futile to try to position oneself for any specificsetofconditionsthatmightbeahead.Theoddsofgetting it right are too low,and the costs of getting it wrong are too high. Strategic Flexibility responds to this challenge with a four-phase approach that overcomes the paradox of traditional strategy models by abandoning entirely the need to predict the future,yetstillpositioningfirmstorespondtothreatsorcapitalize on opportunities they are likely to encounter (see Figure 1.The Strategic Flexibility Framework). Consider each of the four phases in turn. Strategic flexibility begins by developing a set of scenarios that boundfuturepossibilitiesalongdimensionsofparticularinterest. Inthecaseofpositioningoneselftocopewiththebusinesscycle, it can be useful to think of scenarios for recovery in terms of the fourstereotypical“shapes”thatthecycleofrecessionandrecovery typically has – aV,U,W,or L (see Figure 2.Scenarios for Recovery) FORMULATEFORMULATE Withthesescenariosinplace,thenextstepistocreateanoptimal strategyforeachscenariousingtheconventionaltoolsofstrategy formulation.Inthecaseofourfourscenariosforeconomicrecovery, most executives would probably make short work of developing anoptimalstrategyforagivenrecoveryprofile.Toldwithcertainty thatarecessionwilllasteightmonthswithnoquarterlyeconomic
  7. 7. DeloitteResearch–ManagingAmidUncertainty 5 ACCUMULATEACCUMULATE FIGURE 2. BUSINESS CYCLE SCENARIOS SOURCE:DELOITTE RESEARCH The“V” Threetoninemonthsofeconomicslowdown. Rapidreturntopre-recessiongrowthrates. ECONOMIC GROWTH 0% TIME ECONOMIC GROWTH 0% TIME ECONOMIC GROWTH 0% TIME ECONOMIC GROWTH 0% TIME The“L” Severalyearsofeconomicdecline. Unsureandslowreturntomodestgrowthrates. The“U” Twelvetoeighteenmonthsofeconomicdecline. Gradualreturntoacceptablegrowthrates. The“W” A“doubledip”recessionlastingonetothreeyears. Tentativereturntolong-runaveragegrowthrates. contraction more severe than negative 0.5%, and a rapid resumption of persistent 3.5% growth,the appropriate response is clear:to the extent possible,ignore the recession. This strategy formulation effort must be undertaken for each of the other scenarios as well.Various combinations of business- as-usual, cost-cutting, and a measured return to expansion constitute appropriate responses to each of the four possible recovery profiles presented in Figure 2. So far, all this accomplishes is to multiply the work of the strategist: instead of developing one strategy, she must now develop several.However,the power of this approach emerges in an analysis of the commonalities and differences between these optimal strategies. Specifically, those initiatives suggested by all of the optimal strategies constitute the organization’s core strategy – a strategy that can be pursued confident in the knowledge that it will be a useful response to whatever future emerges.Initiatives specific to a particular optimal strategy are called contingent strategies. Examples of core strategies might include investment in customer relationship management capabilities, adopting shareholder-focused performance metrics, and investing in training and human resources development. On the contingent side,massive layoffs can make sense in the event of an extended economic contraction, while investments in foreign markets, new product development, and expanding capacity through acquisition are each keyed to specific types of economic expansion. Firmshavehistoricallybeenforcedtopicktheirbestguessofwhat thefuturewillholdandrespondbyimplementingasinglestrategy keyed to the demands of that set of assumptions.However,given the fundamental impossibility of predicting, this approach will inevitability lead to potentially bitter regret (see Figure 3. The Benefit of Hindsight Is Regret).
  8. 8. 6 DeloitteResearchStudies Strategic Flexibility in the Communications Industry: Coping with uncertainty in a world of billion-dollar bets. StrategicFlexibilityintheFinancialServicesIndustry: Creating competitive advantage out of competitive turbulence. StrategicFlexibilityintheEnergySector: Competinginadecade of uncertainty,2000-2010. Strategic Flexibility in Life Sciences: From discovering the unknown to exploiting the uncertain (forthcoming). Strategic Flexibility in the Media Industry: Reel options in the pursuit of digital convergence (forthcoming). Deloitte Research has been developing the concept of strategic flexibility for over two years.Through a series of industry-specific research reports and other publications,Deloitte Research professionals, in collaboration with their Deloitte Consulting and Deloitte &Touche colleagues,have created a body of work that articulates the four phase strategic flexibility framework and demonstrates its usefulness in a wide range of applications. Many of the items below are available from Deloitte Research at or upon request at OtherPublications “Real Options in Real Organizations” Creating and exercising real options through corporate diversification. Chapter 2 in Innovation and Strategy, Operating Flexibility, and Foreign Investment:New Developments and Applications in Real Options. L.Trigeorgis (ed.) Oxford University Press,2002. “Real Options and Restructuring the Communications Industry”TelecomInvestor,December 2001. “Lead from the Center”How to manage divisions dynamically. Harvard Business Review,May 2001. “TrackingStocksandtheAcquisitionofRealOptions”Journal of Applied Corporate Finance,Summer 2000. “Hidden in Plain Sight” Hybrid diversification, economic performance,and real options in corporate strategy,in Winning StrategiesinaDeconstructingWorld,J.Wiley & Sons,2000. 6
  9. 9. DeloitteResearch–ManagingAmidUncertainty 7 Developing a complement of core and contingent strategies provides insights into the resources a company has and those it absolutelyneeds,mightormightnotneed,anddoesn'tneed. This in turn highlights some obvious guidelines for action (see Figure 4. A Framework for Accumulating Resources). These existing resourcesnotapplicabletoanyfuturescenarioshouldbedisposed of,while those that are needed for any scenarios should be kept andmaintained. Investmentsneededforonlysomepossiblefuture should be scaled back to a level commensurate with the probability of actually needing them. HumanResources Inthehumanresourcesfield,oneofthechallengesofrecessionary economies is how to cut costs by laying off people without destroying the value that has been built up in a firm’s human capital.After all, there are few organizations that wouldn’t claim proudly that their most valuable asset is their people;but there is no denying that one of the most significant quick-hit cost cutting measures for many firms is in headcount reduction. To cope with this contradiction, Cisco Systems has found a way to create real options on its long-term-valuable, yet short- term-expensive,human assets. Faced with the need to cut costs by reducing its salary expense, in April 2001, Cisco offered 80 employees a unique opportunity:rather than be dismissed outright,they could work fornon-profitorganizationsaspartofanewprogramthecompany initiated called the Cisco Community Fellowship Program. Participants in the program agree to work for one year as a full- time employee of the non-profit organization while being paid by Cisco just one-third of their pay but keeping their benefits and stockplans.TheyalsoretainedaccesstoCisco’straining,continuing education,and e-learning.At the end of the year,the employees will receive an additional two months salary at the one-third rate and will be considered internal candidates for any jobs that become available. Those resources that the firm does not hold and that are irrelevant to any possible future should be avoided, and those relevanttoallpossiblefutureshouldbeaccquired. Butwhatabout resources the company doesn't have but needs in case certain threatsandopportunitiesemergeasdepictedinitsscenarios,but not otherwise? The fundamental challenge that the Strategic Flexibility framework solves is how to prepare for multiple possible futures – each of which requires different responses – simultaneously. This is done through the creative application of real options. Real options are small-scale investments in capabilities a firm might need which confer the right,but not the obligation, to invest more money in the future in order to fully deploy that capability. The power of this approach is evident in the activities of some leading companies in different functional areas. SOURCE:DELOITTE RESEARCH Sell None All Some Resources the firm has Keep and maintain Scale back AvoidResources the firm doesn’t have Acquire Take real options These are elements of the“core” strategy These are elements of “contingent”strategies FIGURE 4. A FRAMEWORK FOR ACCUMULATING RESOURCES RELEVANTTOWHICH SCENARIOS FIGURE 3. THE BENEFIT OF HINDSIGHT IS REGRET SOURCE:DELOITTE RESEARCH ACTION Sell off the widget division Lay off 5,000 workers Restrict new investments HINDSIGHT The upturn started the day we sold it and now it’s making money for the buyer We should have laid off 10,000 since the recession had another two years to run Could’ve bought Acme Inc.for a song and positioned ourselves for the gadget mania
  10. 10. 8 This approach clearly has costs for Cisco – it is paying people who are not working for the company. However, if the economy recovers in the next twelve months to a point that Cisco wants them back,they can be rehired.If the economy remains sluggish, andtheirservicesarenotrequired,Ciscocanthendecidetoeither let them go or,perhaps,renew the agreement. Inotherwords,theone-thirdsalarythatCiscopayscreatesan option on the services of these employees – an option that will come into the money in the event that the recession is short and these employees’ services are required within one year. Since a short recession is certainly a possibility,this option on potentially valuable human resources has allowed Cisco to accumulate the contingent resources associated with a particular scenario while simultaneouslycuttingcostsinordertorespondtotheexigencies of the current environment. Marketing Bell Canada, the dominant local and long distance telecommunications services provider in Canada, is one division among many in the portfolio of BCE Inc.Other operating units in the BCE family include Bell Mobility, a wireless network services provider, Sympatico, an internet service provider and internet portal,andExpressvu,thenation’slargestsatellitetelevisionservice provider,to name only three. BCE’sstrategyisexplicitlyconvergence-driven.Thatis,thefirm is aiming to develop and deploy a number of new services that either bundle existing services or create entirely new ones by combining the offerings of its various operating units. A critical element of successfully executing this convergence strategyisanintegratedcustomerservicemanagementcapability, customer service representatives and call centers are simply too expensive to replicate across all of BCE’s stand-alone and convergence-based product and service offerings. Consequently, within Bell Canada, the beginnings of such a capability are under development. The initiative, called OneContact, is intended to deploy customized Siebel customer relationship management (CRM) software to specially-trained customerservicerepresentatives(CSRs)sothatinquiriesfromany of BCE’s 8 million customers concerning any of its vast array of products can all be addressed through a single customer service infrastructure. But reaching that goal is cannot be done in one giant leap.5 Not only is such an undertaking extremely challenging operationally,buttheuncertaintiessurroundingtheextentofthe capabilities needed are enormous. There are issues with the technology to be sorted out, such as how difficult will it be to integratethecustomerdatabasesofBCE’sdifferentdivisions.There aremarketplacequestionstobeanswered: whatproductbundles will work; which convergence services will succeed and need supporting, and which customer segments will benefit from an integrated customer service capability? And there are organizational issues to sort out: who will be responsible for managing the implementation of such an aggressive transformation; and how will the new customer service infrastructure coordinate with the rapidly changing suite of services being developed in the operating divisions? Bell Canada’s solution to these problems is to launch OneContactasapilotprojectaimedatcross-sellingtoBellMobility services existing Bell Canada customers. For an initial investment of C$10 million,the company has demonstrated that it can“light up the screens” with a customized, cross-divisional CRM system thatcombinescustomerinformationfromthetwooperatingunits. Rolledouttoacarefullytargetedgroupof100,000customers,the newcapabilityisdesignedtoincreaseandaccelerateBellMobility’s penetration of the Canadian wireless market. Designingtheinitialrolloutinthiswaymaximizesthechances ofsuccess. Mobilephoneserviceisawell-establishedofferingwith good growth potential: mobile phone penetration in Canada is about 35%,and is expected to exceed 50% within the next three tofiveyears. Furthermore,aswirelineandwirelessphoneservices becomeincreasinglyinterchangeableinthemindsofconsumers, convergence between these two divisions is the likeliest to prove viableintheshortterm. Consequently,anintegratedBellCanada/ Bell Mobility CRM capability is likeliest to prove worthwhile.
  11. 11. DeloitteResearch–ManagingAmidUncertainty 9 ResearchandDevelopment The automobile industry has long struggled with the notion of what comes after the internal combustion engine (ICE).Electric carsseemtheanswer-buthowtopowerthem?Batteriesseemed promisingforawhile,nolonger.Lackingaccelerationandrange, andrequiringacompletelynewinfrastructuretorechargethem, the batterypowered vehicle will likely remain confined to golf greens. Anotheralternativeisthefuelcell.Combininghydrogenand oxygen and adding a little energy results in water and electric current.Thesedevicesseemedmuchmoreintriguing,promising to overcome the key limitations of batteries. Consequently, General Motors and many other automakers began working furiously, both on their own and in conjunction with smaller companies focused on fuel cell technology,to develop the fuel cell-driven car. Such devices are still a long way from viable,however.Fuel cellsremaintoobig,tooheavy,andtooexpensiveasviablepower sourcesofautomobiles.Itwilltakemanybillionsofdollarsmore andmanyyearstoadvancethetechnologytothepointthatthe ICE is endangered. Faced with a recessionary economy,budgets for such long termandexpensiveresearchcancomeunderparticularpressure. GeneralMotors,though,hashituponaninnovativesolution.The fuelcelltechnologydevelopedsofarisalongwayfrompowering your car - but the refridgerator-size units are well up to the task of keeping the lights on in your home or small office building.7 Entering what the utilities industry calls “distributed generation technology” seems on the face of it to be diversification away from their core automotive business, and theonewouldthinkthatthelastthinganycompanycantolerate is taking their eye off the ball during a tough market. But this move actually serves two purposes.First,it enables GM to begin to earn a return on its significant investment in fuel cell technology,whichisnotonlygoodforshareholders,butwillalso allow the firm to maintain and sustain the human capital it has At the same time, this pilot provides valuable learning opportunities,and constitutes a real option on expanding both the scale of the current integrated OneContact offering – that is,rolling it out to more customers – and the scope – that is, including the services of other services from other BCE divisions. The result is that BCE has remained conservative in making potentially large investments in expanding its CRM capabilities,but istargetingitsinvestmentdollarsinsuchawaythattheyarecreating optionsonexpandingtheirprojectsintheeventofincreasingmarket enthusiasm. Operations FleetBoston Financial and Morgan Stanley created Clareon in mid-2001, a joint venture with the mandate to develop internet-based payments systems that lower processing costsfor high-value transactions.6 Clareon’s primary service offering, Paymode, targets financial institutions’ cash management customers. Upon completing a transaction,thesellergeneratesaninvoiceontheinternetandsends ittothebuyer.Theinvoiceisapprovedbythebuyer,whothensends payment and remittance information to Clareon,which then debits and credits the appropriate accounts. FleetBoston intends to offer PayMode to its 500,000 cash management customers,and the business is expected to generate revenues of in excess of US$1 billion.With that much at stake, it is critical to have a fully functional service from day one. Tothatend,FleetBostonispilotingPayModeonitsowninternal billing processes. This approach is especially creative, for it allows FleetBoston to explore an important costcutting opportunity while simultaneouslycreatinganoptiononarevenueenhancinginitiative. If internal deployment proves effective at cutting FleetBoston’s costs, the bank will have removed some of the uncertainty concerningtheusefulnessofthetechnologytoitscashmanagement customers.Inotherwords,itwillhavedemonstratedthattheoption on PayMode is“in the money,”and so the incremental investment needed to introduce PayMode as a competitive service offering is justified.
  12. 12. 10 OPERATEOPERATE environment, passing information up and down a traditional hierarchy introduces time lags in decision making that doom a company to miss fleeting opportunities. Devolvingauthorityinthiswayisarguablytherightapproach if the objective is to create an organization that is nimble – as opposed to flexible.Nimble organizations attempt to respond to the environment around them by changing just as fast as it does. However,inawidevarietyofindustries–fromthefinancialservices businesstotelecommunications,hightechmanufacturing,media, utilities,and pharmaceuticals,among others – responding in real time as uncertainties are resolved is frequently not a viable alternative. The investment lead times are too long,the implementation challenges too significant, and the market opportunities too fleeting. The answer for these industries is to become flexible throughthekindofadvancepreparationthatmakesitpossibleto change quickly by calling upon capabilities that the firm has developed to cope with the demands of a variety of scenarios. In the case of Cisco,for example,the firm positioned itself to respond quickly in the event of rapid growth following a short recession by taking a real option on its valuable human capital. This is a smart move, because it can take a great deal of time – indeed, perhaps many years – for new employees to equal the productivity of long-time members of the organization. But recovery can arrive in a matter of just weeks. When an organization accumulates resources through these typesofrealoptions,decentralizeddecision-makingprocessesare generally inadequate. Making such investments requires a long-term perspective and horizon-scanning capabilities that are typically a strength of a company’s most senior executives.Thus, creating flexibility in the Accumulate phase by acquiring the appropriate real options is uniquely the purview of the corporate office. developed over the years. Second, and perhaps much more valuable, is the real option this move creates on developing fuel cell powered automobiles. Using the distributed generation market as a proving ground for its fuel cell technology and manufacturing techniques, GM will gain invaluable information about the long-term viability of fuel cells as powerplants for automobiles. What GM learns from these initial,and potentially profitable, forays into non-automotive applications of fuel cell technology will put the firm in a much better position to determine how aggressively to pursue fuel cell automobile engines in the future. If the knowledge gained suggests that fuel cells are a viable alternative to the ICE – that is,if the option appears to be coming into the money – then GM can exercise the option by devoting more research to extending the technology to the car market. Alternatively, the firm can sell off its distributed generation business - that is, abandon the option - and begin as the search for a successor to the gasoline engine. The organizational implications of mobilizing a company around strategic flexibility are enormous.8 Whereas the challenges of traditional strategy implementation have concerned aligning the behaviors of many people with a single,clear vision of the future, companies must now enable people to cope with uncertainty – and the resulting multi-track approach of core and contingent strategies.Making this shift poses a number of unique challenges totraditionalthinkingontheroleofmanagers,,andespeciallythe corporate office of diversified firms. Conventional wisdom holds that, in the face of turbulence, decisionmaking and strategy formulation must be pushed down tothelowestlevelspossibleinanorganization,basedonthebelief that uncertain environments are characterized by rapid change and, consequently, windows of opportunity are narrow. In this
  13. 13. DeloitteResearch–ManagingAmidUncertainty 11 Additionally,theOperatephasedemandsamuchmoreactive corporate office than is typically required for implementing traditional strategic plans. Companies can only realize the value of the flexibility they have created through their real options portfolio if they exercise or abandon them appropriately, and decidingwhenandhowtodothiscallsforforcefulleadershipfrom the top. Forexample,despiteradicallydifferentpersonalstyles,Sumner Redstone at Viacom (the communications giant and parent company of CBS) and Martin Sorrell at WPP (the world ‘s largest and most diversified corporate communications firm and parent company of Ogilvy & Mather) do not appear to focus on process issuesorleadershipsuccessionthewaysuchlegendarymanagers as Jack Welch at General Electric or Larry Bossidy at the former AlliedSignal are reported to have done. Rather, they are deeply involved in determining and driving when and how once autonomous and independent divisions should begin to cooperate in order to capture the value of synergies in the face of changing competitive pressures. Abandoning options requires just as much, if not more, direction from the corporate office.An investment’s option value lies primarily in the flexibility to avoid making money-losing investments. No one would ever exercise a financial option that was out of the money,and the same should apply to real options as well. The problem is that organizational politics frequently intervenes and specific projects end up remaining funded long after any reasonable hope of turning a profit has evaporated. Forexample,inthecaseofCisco’sflexibleapproachtohuman resources, it may be difficult to decide not to hire back the 80 people who took part in its Community Fellowship program – for to incur the expense of keeping them on partial salary for a year onlytolaythemoffanywaymightsuggestthattheprogramitself was a failure.Few managers would want such a failure associated with their efforts. To view an unexercised option as a failure, however, is to overlook the benefits of hedging strategic risk.As with insurance policies,just because it might turn out that they are not needed doesnotmeanthattheyareabadidea.IfCiscoendsupnothiring these people back because the recession turns out to be longer than anticipated,one can only criticize the company in hindsight. Whenthedecisionwasmadeinmid-2000,itwasaninnovative and bold move that created valuable flexibility for the company. Cisco had no way of knowing what its human resource requirementswouldbeinthefuture–butitknewithadtoreduce itssalaryexpensesimmediately.Thefellowshipprogramachieved both ends,allowing the company to compete more effectively in the present while still positioning it to compete in a range of possible futures – the very essence of strategic flexibility.
  14. 14. 12 Conclusion About the duration of the recession we have this to say: “the shorter the better”. Beyond this,we have no further insight. However, organizations that use this time of economic contraction and uncertainty to prepare themselves to respond to thefutureasitpresentsitselfwill,onaverage,deliversubstantially more value to their shareholders than organizations that bet on a single outcome. Of course, flexibility comes at a cost; the organization that executes a strategy premised on a prediction of the future that turns out to be right will always do better than an organization thathasinvestedinflexibility.Eachwillbeequallywell-positioned for a given set of circumstances, but the inflexible company will havedonesoatthecostofbearingconsiderablygreaterriskalong the way. Counting on “prediction-based” approach to succeed consistently is hardly advisable, however: it amounts to betting shareholders’ money on management’s clairvoyance. One need only remind oneself that Las Vegas was not built on the backs of the winners to see the folly of this as a foundation of strategic planning. Consequently, the combination of scenario, based planning and a calibrated commitment to contingent strategies through real options – that is,Strategic Flexibility – offers a powerful tool for an organization to be able to act in the face of uncertainty. In the words of Peter Drucker,“prediction is not a worthwhile activity.”Butneitherisinactivity.StrategicFlexibilityallowsoneto abandon prediction and accept uncertainty without being paralyzed by it, and instead act forcefully and purposefully confident in the knowledge that a firm’s strategy has prepared it for whatever lies ahead.
  15. 15. DeloitteResearch–ManagingAmidUncertainty 13 End Notes 1 Weber, Steven (1997), "The End of the Business Cycle”, Foreign Affairs. 2 “Recession -What Recession?”,Investor’sChronicle,July 14,2000. 3 “Uncertainty Inc.”,TheWall Street Journal,October 16,2001. 4 “Cease Fire: Companies That Keep Workers in Hard Times Can Win,“ Forbes,November 26,2001. 5 For more on overcoming the challenges of implementing CRM, see“How to Eat the CRM Elephant,”Deloitte Consulting,2001. 6 Depaula, Matthew. “Payments: Busting a B-2-B Move”, FutureBanker,June 18,2001. 7 “Stationary draw”,The Economist,August 9,2001 8 See Raynor, M.E. and J. L. Bower (2001),“Lead from the Center: Howtomanagedivisionsdynamically”,HarvardBusinessReview, May.
  16. 16. 14 Author MICHAEL E.RAYNOR Tel:+1.416.874.3308 Email: Michael Raynor is a Director in Deloitte Research. His research focuses on corporate strategy. He has a doctorate from the Harvard Business School,an MBA from the Ivey School of Business,and an undergraduate degree in Philosophy from Harvard University. He is based inToronto. The author would like to express his thanks and appreciation for comments and advice from a number of colleagues, especially Dwight Allen (Washington DC) and Gordon Coutts (Toronto). About Deloitte Research Deloitte Research,a permanent thought leadership organization established by Deloitte &Touche and Deloitte Consulting,is dedicated to providing ongoing research and insight into the critical global and industry-specific issues facing business today.Comprised of both practitionersanddedicatedresearchprofessionalsfromaroundtheworld,DeloitteResearchcombinesindustryexperiencewithacademic rigor.Our research identifies and analyzes market forces and major strategic,organizational and technical issues that are changing the dynamicsofbusiness.Itfocusesonleading-edgeindustry-specificissuesandglobaltrends,providinginsightintonewevolvingchallenges. FormoreinformationaboutDeloitteResearchpleasecontacttheGlobalDirector,AnnBaxter, Recent Deloitte Research Strategy and OperationsThought Leadership: s Collaborative Knowledge Networks: DrivingWorkforce PerformanceThrough Web-Enabled Communities s Digital Loyalty Networks: eDifferentiated Customer and Supply Chain Management s Mobilizing the Enterprise:Unlocking the RealValue ofWireless s Strategic Flexibility in the Communications Industry:Making Billion-Dollar Bets in aWorld of Uncertainty s Strategic Flexibility in the Energy Industry:Competing in a Decade of Uncertainty:2000-2010 s Strategic Flexibility in the Financial Services Industry:Creating Competitive Advantage Out of CompetitiveTurbulence Please for the latest Deloitte Research thought leadership or contact us atTel:+1.212.492.3791 or
  17. 17. DeloitteResearch–ManagingAmidUncertainty 15 ©2001 Deloitte Consulting and Deloitte & Touche LLP. All rights reserved. ISBN 1-892383-99-3 About Deloitte Consulting and Deloitte &Touche DeloitteConsultingisoneoftheworld’sleadinge-Businessconsultingfirms,providingservicesinallaspectsofenterprisetransformation, from strategy and processes to information technology and human resources. Deloitte & Touche,one of the nation’s leading professional services firms, provides assurance and advisory,tax,and management consulting services through a network of over 30,000 people. Deloitte Consulting and Deloitte & Touche are parts of Deloitte Touche Tohmatsu, one of the world’s leading professional services firms,delivering world-class assurance and advisory, tax,and consulting services.More than 90,000 people in over 130 countries serve nearly one-fifth of the world's largest companies as well as large national enterprises, public institutions, and successful fast-growing companies.Ourinternationallyexperiencedprofessionalsdeliverseamless,consistentserviceswhereverourclientsoperate.Ourmission is to help our clients and our people excel.
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