The last 10 years, particularly the recent 18 months, featured unprecedented world events — political surprises, economic shocks, and revolutionary technologies to name a view — and considerable uncertainty. Our interconnected world means that global uncertainties have increasingly local ramifications; and the question is how do firms make effective strategic decisions in this context?
In June 2016, the world was shocked by the UK’s decision to exit the European Union (EU); pollsters with their years of experience and proven methodologies got it totally wrong. More was to follow with Donald Trump’s election victory in November, as well as the resignation of Italian Prime Minister Matteo Renzi in December, following the resounding defeat of his referendum on constitutional reforms. There was also the election of the new French President Emmanuel Macron (defeating Marine Le Pen, as well as the outright favourite from earlier rounds François Fillon of the conservative Republicans); and this year, sanctions were levied against Qatar by its Arab
neighbours.
Not to be outdone, Kenya’s elections in August — results returned incumbent President Uhuru Kenyatta with 54% of the vote — were recently voided; and pundits are now watching the upcoming polls in Germany (the largest economy in the EU).
And what about the Indian government sending its population into a panic by announcing withdrawal of 1000 and 500 rupee notes overnight? There were also health and associated economic shocks relating to the spread of the Zika virus in Brazil, threatening entire populations in Latin America, adversely impacting trade and tourism.
Then we’re grappling with driver-less cars, taxis that are not taxis, and home deliveries by drones? And then there is wealth that is stored in new intangible forms — c/o fintech, blockchain, cryptocurrency (eg bitcoin) and dematerialisation (the move from physical certificates to electronic book keeping) — that some of the best central bankers are yet to understand; with China deciding to block their use to protect its currency, among other reasons.
These disruptive technological innovations are fuelling volatility and uncertainty in markets across the globe.
Uncertainty in all facets of life is being amplified and accelerated because of technology and globalization. Businesses are continuously confronted with decisions that must be made under different degrees of uncertainty. Charting and executing a company’s strategic direction is therefore about managing uncertainties and understanding the relationships between the risk and opportunities along each path. However, before proceeding, we should pause a moment to distinguish between the often-confused terms “risk” and “uncertainty”.
Risk and uncertainty are two distinct features of random environments, and they can affect individuals’, managers’ and policy-makers’ behaviour very differently. On the one hand, risk may simply be characterised as randomness that can be measured precisely; or as the Concise Oxford English Dictionary puts it, risk is a “hazard, a chance of bad consequences, loss or exposure to mischance”.
Noteworthy, and it is a common misconception, that the dictionary’s definition focuses on downside risks and ignores upside risk — the chance of making a positive return. Uncertainty, on the other hand, is an event that has unknown probability.
It has long been argued that if risks were the only relevant feature of randomness, then well-organized financial institutions should be able to price and market insurance contracts that only depend on risky phenomena. Uncertainty, however, creates frictions that these institutions may not be able to accommodate; and so, we can’t insure against uncertainty. So, while the concept of risk has been the subject of many studies and practical approaches, I’d like us to focus on uncertainty in strategic management.
At the macro-level, uncertainty has received substantial attention as a potential factor shaping the depth and duration of the Great Recession. For example, the United States’ Federal Open Market Committee (FOMC) emphasized uncertainty as a key factor that drove the 2001 and 2007-2009 recessions, while a study done in 2012 showed that the main contributions to the decline in US output and employment during the 2007-2009 recession were financial and uncertainty shocks.
Other studies have shown that the relationship between firm/plant-level shocks to total factor productivity (TFP) is strongly countercyclical; in other words, uncertainty rises steeply in recessions. Similarly, uncertainty is strongly countercyclical at the industry level. That is, the yearly growth rate of output is negatively correlated with the distribution of TFP shocks to establishments within the industry. Hence, both at the industry and at the aggregate level, bad times are also uncertain times.
At the firm level, how do managers, driven to maximize shareholder return, make decisions in uncertain environments? In conventional investment analysis it is assumed that projects with returns more than certain threshold rates, are worth undertaking as they add to the value of the company. This is equivalent to projects having a positive net present value (NPV) — a process of discounting future cash flows at the estimated cost of capital to present day values — or said differently, projects with negative NPV ought to be rejected, unless there is some compelling strategic benefit that will unlock or preserve the firm’s value. Managers are also taught to use a higher discount rate — effectively lower the project’s NPV — to account for higher risk.
Unfortunately, the magical NPV approach has its limitations. Very often strategic decisions (most times an investment) are for peculiar projects with no readily appropriate discount rate — one that correlates to a traded security or that has properties like previously implemented projects being available. Also, NPV does not incorporate the various options (directly and indirectly or that may occur due to different conditions during the lifecycle of the investment), which managers should consider in arriving at their strategic decisions.
As a result, management’s decision is reduced to a binary one — yes or no — and thereafter management becomes fixated on implementing the agreed operational strategy. And guess what, decision-making with NPV is only useful in a stable world. But as everyone must know by now, unforeseen events occur, or put differently “c…p happens — oh, I meant “cramp” like the one associated with the uncertainty that manifested with two Jamaican medallists from the 2002 World Junior Championships in Athletics, Mrs Aneisha McLaughlin-Whilby and Dr Hon Usain St Leo Bolt, experiencing left hamstrings strains/tears during their respective relay finals at the London 2017 World Athletics Championships.
A more appropriate method to aid in decision-making with uncertainty is real options. The main benefit of this approach is that it emphasises the asymmetry between gains and losses in strategic options; but that’s a discussion for another time.
More importantly, the inevitable uncertainties that come with business — particularly in fast-moving, hypercompetitive, and dynamic industries (e.g. retail, technology, food and beverage) — require flexibility and agility rather than fixation on strategic choice and subsequent implementation; and new methodologies to provide information for speedy and effective decision-making.
Managers, based on the arrival of new information, need to be able to change course to capitalize on favourable new opportunities and cut losses in the event of adverse developments. Flexibility will expand their strategy decision-set, from “go”/ “no- go”, to include: deferral, expansion, adaptation, contraction, and abandonment, to name a few.
Agile firms are those that can make informed adjustments, to keep up or get ahead of their competitors, based on what’s known in mathematics and economics as the second derivative — improving the rate of change itself. In business, a second-derivative strategy means focusing not just on the one-time change a project is designed to deliver, but also the additional changes an enterprise can make as by-products of that project which will make future projects easier.
By doing so, companies can create an acceleration effect that can ultimately cut development costs and reduce their speed of delivery from months to days.
In uncertain situations, managers should aim to adopt second-derivative strategies that treat agility as a goal in itself — enabled by enhancing capabilities, reusable components, and standardized processes that constantly create value at increasingly faster rates. Only then will they be able to raise the speed limit of their businesses, keep up with the world around them, and create lasting competitive advantage.
A good example of the power of a second-derivative strategy is the rapidly evolving Tesla Motors. Tesla’s strategy was to build cars like the design approach of smartphones — making them safer, smarter, and more capable over time — based on operating systems that may continuously improve using over-the-air software updates.
This feature has created significant brand equity and goodwill from its customers during Hurricane Irma — by the flip of a switch, Tesla owners were able to get extended battery-life to facilitate their evacuation from Florida.
Unfortunately, too many companies, when they think about agility and change, still rush to build huge new IT systems that they hope will lead to big improvements — in three years, if they’re lucky.
In the meantime, their capabilities will have stagnated and the complexity of these systems makes it difficult and expensive to drive any further change. As the pace of technological advance, companies that can’t continue to change quickly find themselves falling even farther behind their nimble competitors.
Importantly, in uncertain environments, it is essential that we embrace the power of the latest information system capabilities.
Recently, machine-learning techniques (which in many cases aren’t particularly new) have become dramatically more practical due to the ready availability of computing power and a much wider variety of data sources. Some may argue that these are “pie in the sky” prescriptions, but the reality is that access to tremendous power processing is widely accessible at no cost — I didn’t mistype, I did say ‘at no cost’ — through IBM’s Watson (a cognitive system, empowering a new relationship between people and computers, that combines artificial intelligence (AI) and sophisticated analytical software for optimal performance as a “question answering” machine).
So, even at the microenterprise level, developing strategic plans at times of uncertainty can advance techniques which are obtainable to improve management decision-making, especially since customer behaviour is morphing as the digital revolution continues unabated.
Looking ahead, geopolitics and globalization have never been more uncertain. With our interconnectedness — for now at least — strategic management decisions must demonstrate flexibility and agility, with the application of modern dynamic analytical modelling capabilities that will help to frame corporate and competitive strategies at times of great uncertainty. Deshazor Everett Womens Jersey
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