The Strategy Paradox

The future never gets here. […] Once an organization has gone through the process of building scenarios, developing optimal strategies, and identifying and acquiring the desired portfolio of strategic options, it is time to do it all over again. As events unfold, the relative probabilities attached to certain outcomes can be updated. Some options will be exercised, others preserved, still others abandoned. Each new piece of information now becomes clue to where in the possibility space the future, defined by a particular time horizon, will fall.Once you start thinking in terms of scenarios and options, current events are no longer merely current; they become signposts for the future.

INTRODUCTION

KEY TAKEAWAYS

• The hallmark of a great idea is that, once understood, you feel as though you knew it all along.
• Most strategies are built on specific beliefs about the future. Unfortunately, the future is deeply unpredictable. Worse, the requirements of breakthrough success demand implementing strategy in ways that make it impossible to adapt should the future not turn out as expected. the result is the strategy paradox […] Resolving this paradox requires a new way of thinking about strategy and uncertainty.
• the opposite of success is not failure, but mediocrity.
• Theodore Roosevelt, the twenty-sixth president of the United States, explained this much to us when he argued that the credit belongs to those actually "in the arena," whose faces are marred by "dust and sweat and blood." His point was that victory demands valiant action, and that valiant action necessarily brings with it the risk of defeat.
• Therein lies the strategy paradox: the same behaviors and characteristics that maximize a firm's probability of notable success also maximize its probability of total failure.
• The cause of the strategy paradox is as obvious as it is overlooked. A successful strategy allows an organization to create and capture value. To create value, a firm must connect with customers. For firm to capture value, its strategy must be resistant to imitation by competitors. Satisfying customers in ways competitors cannot copy requires significant commitment to a particular strategy, that is, strategic commitments, to unique assets or to particular capabilities. Commitments are a powerful determinant of success because they make a strategy difficult to imitate.
• The strategy paradox, then, arises from the collision of commitment and uncertainty. The most successful strategies are those based on commitments made today that are best aligned are best aligned with tomorrow's circumstances. But no one knows what those circumstances will be, because the future is unpredictable. […]As a result, success is very often a result of having made what turned out to be the right commitments (good luck), while failed strategies, which can be similar in successful ones, are based on what turned out to be the many ways to wrong commitments (bad luck). In other words, the strategy paradox is a consequence of need to commit to a strategy despite the deep uncertainty surrounding which strategy to commit to. Call this strategic uncertainty.
• Firms that avoid strategic risk survive but do not prosper. Firms that accept strategic risk reap either great reward or utter ruin.
• organizations pursuing the most commitment-intensive strategies generate the highest returns, but they also suffer the highest mortality rates.
• The future is a range of possible outcomes, not a specific set of circumstances that will inevitably come to pass.
• The strategy paradox is a consequence of the conflict between commitment and strategic uncertainty. The answer to the paradox lies in separating the management of each, charging some with the responsibility of delivering on the commitments the organization has already made, and others with the task of mitigating risk and providing exposure to promising opportunities.
• Perhaps more controversially, applying the principles of Requisite Uncertainty implies that CEOs should not see their role in terms of making strategic choices-that is, commitments. Rather, they should focus on building "strategic options," that is, creating the ability to pursue alternative strategies that could be useful, depending on how key uncertainties are resolved.
• Highlighted here is the profound difference between "growth" options and true strategic options. [..] A strategic option is an option on an element of an alternative strategy that might or might not be simple not simply an option on further investment in a new business that might or might not succeed.
• The resulting framework, called Strategic Flexibility, has four phases:
• Anticipate: build scenarios of the future
• Formulate: create an optimal strategy for each of those futures
• Accumulate: determine what strategic options are required
• Operate: manage the portfolio of options
• Success demands commitments to hard-to-copy, hard-to-reverse configurations of resources and capabilities that are aligned with the competitive conditions of a market.
• What assumptions are my strategies based on, and what reasons do I have to believe those assumptions will prove correct?
• "path dependency": what you do now affects what you can do later.
• because the future is perpetually unpredictable, no company knows whether to learn from its defeats, replicate its successes, or remake the rules entirely.
• As it turned out, the key driver of adoption in the new music industry ecosystem was the ease with which people could acquire and manage their exploding libraries of digital music files. Apple, thanks to its history success there of hardware/software integration, was perfectly positioned to solve allowed it to create iTunes, a precisely that problem, and its terrifically successful online digital music store.
• Sony learned well the lessons of its previous wars. The problem is that the next is war is always different from the last one, and it is almost never possible to tell just what those differences will be.
• understanding the past is very different from predicting the future.
• Among Michael Porter's many contributions to management thinking, in my view the most substantial and seminal is that all strategies can be thought of in terms of their position along a continuum between product differentiation and cost leadership. Porter argues unambiguously for strategic purity: Becoming stuck in the middle is often a manifestation of a firm's unwillingness to make choices about how to compete. It tries for competitive advantage through every means and achieves none, because achieving different types of competitive advantage usually requires inconsistent actions.
• Strategies are most successful when they have built up a position in the market that competitors cannot readily copy. Those strategies that require commitment over time are the most difficult to emulate, for generally those strategies that take time to build will take time to duplicate. It is not enough to choose a pure strategy: a firm must choose a pure strategy that can only be implemented successfully through long term commitment, for only commitment ensures that you will create something resistant to opportunistic replication by competitors.
• Good strategies are not necessarily fragile, but they are intricate, with many interdependent, tightly linked components.
• Risk is generally decomposed into "systematic" and "unsystematic" risk. Systematic risk affects "the system," that is, the overall economy, and is generally unavoidable.
• The more an organization pursues extreme profits, the more it must differentiate itself from its competition and the more it must make the kinds of strategic commitments that expose it to the ravages--and the rewards— of strategic uncertainty.
• Strategic uncertainty would simply not exist if companies could choose the right strategy and stay there (a stable environment), shape the environment to their strategies (a controllable environment), or prepare themselves for a future they see coming (a predictable environment).
• An adaptable organization can change itself in important ways so that it remains attuned to the demands of the environment in which it competes.
• Companies afflicted by fast change are not victims of bad management per set rather, they find themselves designed for conditions that suddenly no longer exist.
• In business environments, this kind of "long fuse/big explosion" change often takes the form of "new-market disruption," a particular type of disruptive innovation. In new-market disruptions, two different business models develop largely independently of each other.
• In a classic paradox, during the good times there was no need for change, and by the time it was obvious that radical change was needed, there was no capacity to effect it.
• And disruptive innovation is a powerful force for economic change, manifesting itself as either fast change (new-market disruption) or slow change (low-end disruption).
• In A New Kind of Science, Stephen Wolfram identifies three mechanisms of randomness. The first two are relevant for now:
• Randomness injected into an otherwise orderly system from its external environment. Call these “exogenous shocks."
• Randomness in initial conditions. A system might be orderly but highly sensitive to its starting position. If the starting position--the initial conditions-is anything less than orderly, a process of amplification transforms those inputs into random output. This is the domain of chaos theory.
• The inescapable conclusion, then, is that randomness--the lack of order or pattern-is a necessary component of every system we might want to understand and control. We are doomed to either draw our boundaries too narrowly, leaving ourselves open to an injection of randomness from the environment, or to underspecify the initial conditions that determine the ultimate outcome. Frequently, we are victims of both. Either way, it is uncertainty, not predictability, that best characterizes our future. Wolfram's third mechanism is internally generated randomness, He explains this in terms of the contributions that each element of a system can make to randomness.
• The larger point is that any company that is perfectly rational is perfectly predictable, and any company that is perfectly predictable is easily exploited when it is in a position of weakness. A judicious injection of "deliberate irrationality" into the mix can create enough uncertainty to prevent companies in disadvantaged positions from being exploited as thoroughly as they otherwise would be.
• It is only in high-commitment/high-uncertainty contexts that a form of strategy "dilemma" emerges as a result of a pincer between a need to commit despite an inability to predict.

• If strategic uncertainty is the question, time is the answer. The longer the time horizon over which a strategy must a play out, the greater the range of possible outcomes that must be considered and the less certain one can be of the probabilities associated with any given result.
• Most organizations seek to grow, and there are essentially two ways to achieve this end: do more of what is being done (increasing scale), or do new things (increasing scope).
• Structure follows strategy because, as Chandler put it: Structure has been the design for integrating the enterprise's existing resources to current demand; strategy has been the plan for the allocation of resources to anticipated demand
• None of these companies would have fared any differently in the long run had they better executed those things to which they had committed themselves. They did not need to be better; they needed to be different. The reason they could not be different quickly enough and in the right sorts of ways is that these companies had true strategies: specific sets of capabilities that were resistant to rapid imitation by competitors, but as a result difficult to change. The commitments that make success possible necessarily constrain an organization's latitude for action in the short run that is why commitment-based strategy and organizational adaptability are conflicting objectives.
• It turns out that the skills required to operate in multiple time horizons simultaneously are in terribly short supply
• What capabilities did it need to compete, and more pressingly, what resources would it need to control in order to be able to compete in the future?
• Microsoft might have been confused about which bet to make, but that was perfectly reasonable. In the face of that confusion, it created a series of options, each designed to deal with the demands of different possible market outcomes.
• Diversification within strategy types hedges operational risk, while diversification across strategy types hedges strategic risk.
• What any organization can achieve is in large part a function of three key resources: money, time, and people.
• Time: In one respect, this entire book is about the way in which companies can effectively manage the trade-off between the present and the future.
• Strategic flexibility is very different from run-of-the-mill flexibility or adaptability. "Flexibility" means "change within existing constraints." Flexibility can be helpful, but strategic uncertainty demands strategic flexibility - the ability to change strategies, which is something made largely impossible by the commitments required for success. Creating the real options required to implement new, different, effective, commitment-based strategies on a tempo defined by competitive markets can be done only in the spaces beyond constraints.
• The framework that Holveck adopted has four basic components:
• Anticipate: The existence of strategic risk is a function of the unpredictability of the future. Consequently, managing strategic risk cannot hinge on improved prediction. However, it is possible to bound the range of possible futures that one might face. This is best done with scenarios. By creating a number of scenarios that define the "possibility space" over a relevant time horizon, one can create a framework for discussing the future without having to stake future success on guessing right.
• Formulate: With scenarios in place, it is possible to determine the strategies required to be successful under these different conditions. In other words, there is an optimal strategy for each scenario. Each optimal strategy can then be decomposed into its constituent elements the technologies, capabilities, or other assets required to implement the strategy. Elements that are common to many of the optimal strategies are known as core elements, while those that are common to only a few optimal strategies or perhaps unique to one optimal strategy are called contingent elements.
• Accumulate: Core elements can be pursued without reservation, for there is no strategic risk associated with them; commitment is entirely appropriate, because there is very little chance of having " guessed wrong. It is the contingent elements that demand more creativity and require real options thinking.
• Operate: The accumulate phase results in a portfolio of options covering the contingent elements related to specific optimal strategies described in the formulate phase. These optimal strategies are in turn linked to the scenarios developed in the anticipate phase. The operate phase demands a close monitoring of the environment, which allows the corporation to determine:
• which of its scenarios most accurately captures the most important elements of the future that "arrives," which determines
• which optimal strategy is most appropriate, which determines
• which contingent elements are required, which determines
• which options should be exercised and which should be abandoned.**

Not everything important can be measured, and not everything that can is important. - Albert Einstein

• To paraphrase Peter Druker, for an idea to be of any use it must eventually degenerate into hard work.
• Since scenarios must capture significant variation along a number of different dimensions, it is typically best to express each scenario as a single narrative--a story, if you will. The objective is to capture in high relief the relevant elements of a future in sufficient detail that one can imagine oneself actually living in that world. It must not be a caricature; it must be something you really believe could happen.
• How Do You Create Scenarios?
• 1. Ask the Right Question
• Assessing strategic uncertainty does not mean examining one decision.
• Grappling with strategic uncertainty raises much more fundamental issues, such as: What are the underlying business models that will make sense? What will the balance of power be between the different stake holders? How might this affect the viability of different ways of creating and capturing value?
• The challenge is response to assess the extent to which the relevant uncertainties can be addressed within the context of the existing strategy, or whether they signal potential challenges or opportunities that require fundamentally different strategic responses.
• Defining the question often brings clarity to a related issue: what time horizon should a set of scenarios take into account? Standard prescriptions include rules of thumb such as “double the horizon of your longest-term strategic plan.”
• 2. Identify the Dimensions of Uncertainty
• With a strategic question and a time horizon in mind, the next step is to identify the dimensions of uncertainty that define the relevant possibility space. Often, this is done "bottom up, by clustering individual variables into dimensions. It can also be done "top down," decomposing overall strategic uncertainty into specific dimensions. In either case, a helpful heuristic is to ask what factors make it difficult to commit with certainty to a specific course of action. In other words, whatever it IS you wish you knew is likely defining at least part of a relevant dimension of uncertainty. This last observation captures a critical point: a dimension of uncertainty will tend to be beyond your control.
• 3. Determine the Limits of Uncertainty
• Perhaps the most intellectually challenging element of scenario building is finding the appropriate boundary conditions on each individual dimension of uncertainty.
• Transcending preconceived notions and built-in limits that stunt the ability to imagine alternative futures without descending into wild-eyed hand waving is a delicate balancing act. It is critical at this stage not to look for "consensus" forecasts; seek instead divergent opinions.
• One must scan the environment for credible but outlying opinions with respect to what could happen over the time horizon of relevance and apply one's own judgment in determining which are credible.
• 4. Determine the Final Scenario Set
• A scenario lies at the intersection of the extreme values of the dimensions of uncertainty. It is possible to identify all such intersections using a "truth table.
• 5. Determine the Relative Probabilities
• Ultimately, the purpose of building scenarios is to guide investments in real options on alternative strategies, and the value of those options is tied directly to the likelihood of a given option being exercised. Consequently, probabilities must be assigned to each scenario.
• Collectively, however, the average probability for all team members tends to come out much closer to a uniform distribution, suggesting that the group has no shared view on what the future will bring. Under these circumstances, the scenarios have done their job: every team member accepts that each scenario is plausible but has a strong belief about what the future will hold.

• Committing to extreme strategies offers the promise of great reward but brings with it significant risk. Settling on a middle-of-the-road, or robust, strategy mitigates risk but at the cost of being able to generate significant returns.
• The future never gets here. That is why Strategic Flexibility is illustrated as a loop. Once an organization has gone through the process of building scenarios, developing optimal strategies, and identifying and acquiring the desired portfolio of strategic options, it is time to do it all over again. As events unfold, the relative probabilities attached to certain outcomes can be updated. Some options will be exercised, others preserved, still others abandoned. Each new piece of information now becomes clue to where in the possibility space the future, defined by a particular time horizon, will fall.Once you start thinking in terms of scenarios and options, current events are no longer merely current; they become signposts for the future.
• This book is about the challenge of thinking clearly about a future that we cannot see clearly.
• a deliberate approach makes sense when the future is clear (or clear enough), while an emergent approach is superior when dealing with material uncertainties.
• There is a long-running debate in the strategy field regarding the relative merits of "planning" versus "learning," or alternatively, "deliberate" versus "emergent" strategy-formulation processes. The "planning," or "deliberate," school holds that strategy demands careful coordination and commitment, and that this can only be accomplished through foresight and advance preparation. The "learning, or *emergent," camp responds that the future is uncertain, and that in fact much of the strategy actually crystallizes as a result of the accumulation of many small decisions made in response to immediate concerns.
• Strategy, to be more useful, must begin with a clear identification of uncertainty and how that undermines our ability to commit. In other words, strategy should begin with what we do not know rather than with what we do, for successful strategies must be built upon uncertainty, not in spite of it.
• A firm is vertically integrated when it consists of multiple business units that have material customer relationships with other units in the firm. In other words, vertical integration involves internalizing transactions in goods or services that are outputs of one division and inputs to others. The reason for this diversification was to compensate for the absence of firms providing the services needed to develop and serve a mass market on a continental scale.
• In contrast, Apple's iTunes music store, launched in 2003, has been a huge hit, and in 2006 enjoyed more than 80 percent of all legal music downloads. The organizational difference was that Apple was vertically integrated while its erstwhile competitors were not. Apple's vertical integration allowed it to create and capture value along a much broader swath of the value chain. As a result, Apple created the far more successful online music service. Whether arising from opportunism or unspecifiability, vertical integration's advantages arise through a superior coordination of activities. Achieving this coordination requires the corporate office to intervene in divisional activities more than the corporate office of an unrelated diversifier might: competition between divisions that need to collaborate is potentially destructive.

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