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- 1. Coping with uncertainty– how managers can understand complex, dynamic and unpredictable uncertainties within their macro-environment 2015 STEVEN TOMLINSON STUDENT NUMBER ID: 630044285 UNIVERSITY OF EXETER | BUSINESSSCHOOL Word count:1800
- 2. Executive Summary The reportsetsoutto criticallyanalyse a numberof concepts inorder to identify uncertaintieswithin anorganisationsmacro- environmentinthe followingways. Definingakeyissue thatisof concern to managers Proposingtwosolutions Usingspecificexamplesandsources to supporteachsolution Finally,makesrecommendationsusingone of the solutionsdiscussed,advisingmanagersto adoptthe conceptstocope withuncertainties intheirmacro-environment. Definitionof the issue Thisreportidentifiesthe traditional PESTEL 1960’s frameworkas an insufficientapproach for organisationsandindustries,particularly withinenvironments withlowlevelsof uncertainty,suchasthe digital musicindustry. Thisproblemhas increasingly becomemore apparentto CEO’s whoare recognisingtheir role has changed (Heidrick&struggles,2015) as the environmentinwhichtheyoperatehas become more dynamic,complex and unpredictable. Whenusingthe PESTEL frameworkit is importantto understandthatthe static presentationcanbe consideredalimitation whichfailstoadd value meaningitcanonly provide managementwithalinearoverview of theirmacro-environmentanalysis; therefore there isaneedtomove away from traditional forecasting,tobetterunderstand uncertainties, ensure the longevityand survival of theirorganisation,andtomake betterdecisionsforthe future. The external factorswithinPESTELare dynamicandno considerationof the relationshipsand interactionsbetween changesinthe environmentare explored(G. Burt, 2006). For example,oftenchangesin variables betweenthe macro-environment and the competitiveenvironmentmayoccur ina shortperiod of time thusmakingit difficulttoaccurately predicthow andwhy these factorscan influence the futureof strategy planning.Mintzberg(1987) statesthe problemwithforecastingis organisationsfail to realise potential new strategies,thereforea growingneedformanagers tocontinually scan the external environment forany developmentsthatmayoccur and to proactivelymanage andadaptthe organisationsstrategyaccordingly. In summary,PESTEL istoo general inits approach andfailsto identifyfactorsthat drive change,inparticularindustriesthatgo throughunpredictable majorchanges. Therefore the nextsectionillustratesthe importantof analysingboththe wider,macro- environmentandcompetitive environment, by proposingtwo solutionstoassistmanagers inunderstandinguncertainexternal factorsof an organisationsstrategy. First,byusing scenarioplanningasa tool to further understandcomplex systems. Second,using Real Optionsanalysistoovercome scenario planninglimitations. Finally, tomake recommendations of one the solutionsto justifywhymanagersshouldtake this approach. SolutionOne: Scanning the Future withScenarios Planning Key terms Scenarios: detailedandplausible viewsof howthe businessenvironmentof anorganisationmight developinthe future basedonkeydriversfor change whenthere isa highlevel of uncertainty. Drivers of change:environmentalfactorsthatare likelytohave ahighimpact onthe successof failure of strategy. Source: (A. Thompson et al, 2013)
- 3. There are manytoolsmanagementcanuseto improve theirstrategicplanning,however, scenarioplanning isseenbymanagersas much betterthanothersimilarconceptsasit factors inan extensive range of variablesused to take intoaccount uncertaintiesandbasic trendsoccurringin the macro-environment. Organisationsthatare susceptibletothe followingconditionswill gaincompetitive advantagesbyusingscenarioplanning (P. Schoemaker,1995): Uncertaintyishighinrelationtoa manager’sabilitytoadjustorpredict. Whencostlysurpriseshave happened inthe past. Strategicthinkingwithinthe organisationislow. The competitive industryhasgone throughmajor change or ispredicted to. The organisationwantsa common language andframeworkwithout suffocatingdiversity If there are compellingdifferencesof opinionswherebymanyopinions havingmerit Whencompetitorsare alsousing scenarioplanningwithinthe macro- environment Managers have foundscenarioplanningakey tool inidentifying driversof change within theirenvironment.Thereforeallowingan organisationsmacro-environmenttomove beyondsingularforecaststhatcreate coherentstoriesusedtoidentifyarange of plausible eventsandtoenhance strategic decisionmaking(A.Thompson etal,2013). For example,Royal Dutch ShellGroupused scenarioplanningtopredictthe oil crisisby identifyingthe interactions betweenfactorsin the macro-environment. Indoingso,Shell builtscenariosthatidentifiedinteractions betweenvariables withintheireconomic environmentthatdirectlyimpactedthe business. OrganisationssuchasNorthernRockduring the housingbubble failedtointerpretthe weaksignalswithintheirenvironmentwhich significantly contributedtotheirdownfall. 20% of organisationsfail tointerpret weak signalsoract upon themappropriately which ispredominatelydue to individual biasesand organisational biases(P.Schoemaker,G.S. Day, 2009). For example, managersare simply not aware that emotional andcognitivebiases distorttheirabilitytoidentifyweaksignals. Therefore itiskey managers learnto overcome suchbiasesbyusingthe following approaches (Source:MIT SloanManagement Review): Tap local intelligence Leverage extendednetworks Mobilise searchparties Testmultiple hypotheses Canvassthe wisdomof the crowd Developdiverse scenarios Confrontreality Encourage constructive conflict Trust seasonedintuition BuildingScenarios A. Thompsonetal (2013) statesthere are three levelsof scenario anduncertainties: 1. Global scenarios&general environment uncertainties 2. Focusedscenarios&Industry uncertainties 3. Projectscenarios&company uncertainties It isimportantmanagersmake use of the trendsthat appearwithinthe macro- environmentanalysisandthe driversof change;keyuncertaintiesandthe various interactions inordertobuildplausible scenarios,whichcanbe achieved by identifyingtwoextremes byoff-settingthem togetherinorderto come to conclusionson “By considering a range of alternatives managers become more tuned to what Paul Schoemaker refers to as ‘Weak Signals’ in the environment”
- 4. the positive andnegativekeyuncertainties(A. Thompsonetal,2013). Further,decision makerscan quickly identifyglobaltrends by usingripple intelligence asanearlywarning systemtopredictinteractions inthe environment(Heidrick&struggles,2015). By usingthismethodmanagersare able to sense newopportunitiesfromemerging trends. Figure 2: The Two Axes Method From the setof developedscenarios,stories can be created whichcan thenbe usedto test the bestpossible scenariosforforward thinkingstrategicplanning. Asdepictedin figure 2, a confectionarycompanyhas usedan impact/predictabilitymatrixtogauge highand lowpredictabilityoutcomeswithintheir environment. Whatiskeyto thismethodis managersare assisted inhelpingtheir organisationunderstandandidentifypossible futuresbymappingthe drivingforces tofit scenarioplanninginto the widerstrategic managementsystem. Scenario planninglimitations Source: (K.Miller,G.Waller,2003) Potentiallyunwieldy –withoutlegal, logical consistencyand rigorous examination,scenarios canbe nothing more than imaginative speculations Notquantifiable–as many of the inputstoa scenarioprocessare not quantifiable,the outputislikewise not quantifiable Biases– envisionedscenariosmay reflectcurrentcircumstancesrather than future possibilities;dominant personalitiesorgroupthink canlimit the possibilitiesconsidered Lack of consensus –scenarioplanning allowsfordivergentperspectives, participantsmaynot converge on sharedunderstandingsoracommon strategy SolutionTwo: Real Option analysis Real optionanalysisisanotherwidely acceptedanduseful tool formanagers to betteruncertaintieswithintheir environment(K.Miller,G.Waller, 2003). However, unlikescenario planning,whichisaqualitative method, real optionanalysistakesa quantitative approachwherebyit assistsdecisionmakers toidentify investmentprojectsavailabletothe organisation. Forexample, option analysis candetermine valuecreation, ensuringflexibility inuncertain environments byspreadingafirms investments (byusingoption valuationmodels) overtime which enablesmanagementtominimise unpredictablefinancial risksthat cannot be fullypredicted. Strengths (K.Miller,G.Waller,2003) Valuesflexibility –managerscan acquire,divest,andchange resources as and whenthe strategyneeds Quantitative rigour–provides financial formulasforcalculatingreal optionvaluesotherthanjustnet presentvalue Timing– can informmanagerswhen entryand exitshouldoccur Weaknesses(K.Miller,G.Waller, 2003) Difficulttovalue inpractise Unrealisticassumptionsabout managersand organisations Evaluative,notgenerative Isolatesoptions
- 5. No linktotheenvironment In conditionsof uncertaintyreal optionanalysisisanimprovementon the traditional netpresentvalue analysiswherebymaintaining flexibilitycanimprove the timingof entryand exitdecisions(K.Miller,G. Waller,2003). Further,real option analysisprovidesmanagerswitha code of practise toenhance their optionpricingmodelswhichenables themto examine different approachesto marketentry. Therefore managerscanbetter strategicdecisions. Combining ScenarioAnalysis and Real Option: An IntegratedApproach Althoughbothscenarioplanningand real optionanalysishave anumberof differencesthatcouldbe seenasa limitationfactor, theycanindeedbe combinedtogethertoimprove the strategicplanningconcept(K.Miller, G. Waller,2003). Inaddition, byusing bothmethodsmanagers seekto retainthe strengthsof bothtools whichcontributestoan integrated approach of riskmanagement. It isimportantmanagersmake causal linkagesamongvariousfactors that couldbe outside of the organisations control,whichcan be useful in identifyingchangesinthe environmentthatcouldaffectthe value of firm(P.Corneliusetal,2005). Importantdata shouldbe collectedto determine alternative real option investments,however,itisalsojustas importantnotto isolate real option evaluations,asriskimplicationsof newinvestmentsdependon the portfolio of the business-unitlevel and the corporate level. Therefore, by takingintoaccount real options analysisina qualitativeapproach across the organisationsportfolio can helpmanagersmake betterdecisions aboutfuture investments. Further, there are four stepsmanagerscan follow togaina detailedplausible view of theirenvironment(K.Miller, G. Waller,2003): 1. Scenarioplanning 2. Identifyexposures –bytakingan extensive view of exposure of three categories.General environmentuncertainties, industryuncertaintiesandfirm specificuncertainties. 3. Selectreal optioninvestments – basedon whichexposures enhance the firm’svalue. 4. Implementation –by monitoring keycontingencies,designing flexibilityovertime and reassessingexposures,whereby managementkeep tabson changesof the above steps. Conclusion Identifyingthe limitationsof PESTEL managersare aware of the keyuncertaintieswithintheir macro-environment,suchas, industrybecomingmore dynamic, complex and unpredictable. Scenarioplanningshouldbe adoptedbymanagementinorder to gaina detailedandplausible viewsof how the business environmentmightdevelopinthe future basedonkeydriversfor change,particularlywhenhigh levelsof uncertaintyexistinthe environment.Scenarioplanning was discussedtohighlightdrivers of change withinanorganisation allowingmanagerstomove beyondsingle forecasts,tocreate strategicstories,andtoenhance future decisionmakingprocesses. In addition,the reportfocusedon the strengthsandweaknessesof bothscenarioplanningandreal optionanalysisbymaking recommendationtocounterthe
- 6. limitationsfoundinthe frameworks. References Burt, G., Wright,G.,Bradfield,R.,Cairns,G. and VanDer Heijden,K.(2006) “The role of scenarioplanninginexploringthe environmentinviewof the limitationsof PEST and itsderivatives”International Studiesof ManagementandOrganisation,Vol.36,No.3, pp.50-76 Cornelius,P.,Vande Putte,A.andRomani,M. (2005) “Three decadesof scenarioplanningin Shell”California ManagementReview,Vol.48, No.1 pp.92-109 Heidrick& struggles.(2015). The CEO Report. Retrieved01,December,2015, from http://www.heidrick.com/Knowledge- Center/Publication/The-CEO-Report Miller,K.andWaller,H. (2003) “Scenario Planning,Real OptionsandIntegratedRisk Planning”, Long RangePlanning,Vol.36, pp.93-107 Mintzberg,H. (1987). CraftingStrategy. Harvard BusinessReview,65(4), 66-75. Schoemaker,P.(1995) “ScenarioPlanning:A Tool for StrategicThinking”Sloan ManagementReview,Vol.36,No.2, pp. 25-40 Schoemaker,P.andDay, G. (2009) “How to make sense of weaksignals”MIT Sloan ManagementReview,Vol.50,No.3,pp.81-89 Thompson,A.Strickland,L.,Gamble,J., Peteraf,M.,Janes,A.and Sutton,C.(2013) Crafting and Executing Strategy:Thequestfor CompetitiveAdvantage,1stEuropeanedition, McGraw-Hill,Maidenhead.