Organizing to Plan and to Control Strategic Risk

Speaker A And what I'd like to do this morning is give you sort of skim across the ways of the work that's happening in the strategy of paradox wanted to describe how I was grappling with one particular problem that requisite organizations seem to provide a great deal of help in solving. So rather than making this talk about requisite organizations, I want to talk about strategic uncertainty and approaches to strategic uncertainty and say something I hope potentially helpful about how ro useful to me in my work, in organizing my thinking in grappling this particular problem. So what is strategic uncertainty and why is it solid? Well really what got me started in grappling with the notion of strategic uncertainty was the observation that it seemed to me that there were any number of organizations that had created bridget strategies, implemented them flawlessly and yet nevertheless came near total ruin. Now, my concern was not that somehow all failures consequence of great strategy the universe would have to be a pretty malevolent place in order for that to be true. My concern was that in fact, in many instances organizations failures were all the more nearly complete precisely because their strategies were so great. Now let me elaborate on what I mean by that. Quick example people remember sony betamax. The sony beta max was launched in 1974 and it really was a revolution to me. And in the consumer electronics industry the device that made it possible for people to timeshift television program watch what they wanted to watch when they wanted to watch it 1974, this was of course a revolution. Now sony followed by my understanding, all the prescriptions of what constitutes a great strategy. They understood the markets that they were attempting to serve extraordinary well. They made material commitments to creating a very particular type of technology that was focused on specific customer use and they executed against that plan perfectly. The problem is that all of those perfectly reasonable bets that they made turned out to be the wrong bets. Not because that they were stupid, but because the future was fundamentally uncertain in ways that there was simply no way to define. The story here is not that well then somebody should have somehow seen the future more clearly because I believe that it's fundamentally impossible to do that. Neither can we suggest that somebody should somehow found a way to be adaptable in the face of this uncertainty because after all, once you've made a commitment, well then by definition is very hard to reverse. Commitments that you can change quickly really weren't commitments in the first place. So my point here is that sony and other examples that I go through in the book companies like diventi and north south and so on, all of these companies pursued high commitment strategies in order to make possible the tremendous results that they saw. But it was those very commitments that made it impossible for them to adapt when it turned out they had guessed wrong. The bad news is there was really no way for them to guess right. That then is strategic uncertainty. And the strategy paradox is the fact that from a behavioral perspective at least precisely the same types of behaviors that are required for extreme strategic success namely high commitment positions are also systematically associated with mere total failure. In other words, the opposite of success is not failure the opposite of success is mediocrity. And from a behavioral perspective success and failure are in fact twins. First of all I'd like to start with the observation that in my view at least this notion of strategic uncertainty about attempting to describe it has been fundamentally ignored. An implication of this is that as nearly as I can tell based on some rather large scale research most companies of the consequence are either optimized for mediocrity or face an unacceptable probability of mere total rule. The resolution and this is where requisite organization comes into play the resolution of the strategy paradox is to separate the making of strategic commitments from the management of strategic uncertainty. Now again one central thread I think comes through which is important view commitment is absolutely central to successful strategy. Based on his research organizations must commit themselves over time to specific strategic positions in particular product markets. It is only through making these commitments that it becomes difficult for competitors to imitate what you're doing. And it is this difficulty in imitation this inevitability in strategic position that makes it possible for an organization to actually capture the economic ranks that it creates. So vision a clear compelling vision of the future is necessary for strategic success and a commitment over time to the realization of that vision. Now here's the problem as I suggested with the Sony Anecdote how are you supposed to know what to have a vision of and how are you supposed to know what to commit to? Vision and commitment are necessarily about the future but they are based on decisions and choices made today. And so with the consequence we run into a rather unfortunate situation where because of the way Moser business strategy is done and because we have walked past this unanswered question about the relationship between the choices we make today and the future context in which those choices play out we have actually in my view ignored strategic uncertainty. Now there's a rather characteristic feature of these populations of firms and it's a necessary consequence of the fact that business performance is relevant. What you tend to find is that what you tend to find is that there are large numbers of firms out here at the left with low levels of performance and small numbers of firms out there at the right with high levels of performance. And this is not a criticism it's a necessary function of the fact that only 10% of the population can be in the top 10%. Everybody has to be above average. So there's some small number of firms that do very less. And what most researchers do is they compare the firm that some folks just look at the firms at the left and forget the comparison part. Right? We learned something about research methods insane. And so the Google works will tend to compare the firms that are at the right end of that spectrum the small numbers of high performing firms with the large numbers of low performing firms and look for differences what's unique and common to the high performing firms and what's the difference between them and the low performing firms. Okay, fair enough. In other words, the problem is that by only studying survivors we ignore the failures. And when you include the failures in these studies you find something really quite revealing which is that the behavioral profile of failed firms looks something like this. What you find is that out here at the left where you've got firms with low vision, low commitment and mediocre performance they also all of a sudden go up. And when you go up to the other extreme and you look at those firms with high vision and high commitment and high levels of performance over long periods of time and then look at firms that failed, you know what? They have the same strategic profile. So when you look at the companies that went bust in year four they have exactly the same kind of strategies as the companies that were extraordinarily successful. They just missed the pitch. And so as a consequence that survivor bias has blinded us to strategic uncertainty. Strategic uncertainty in my view has been ignored. We have fundamentally walked past it in our entire corpus of research into strategic performance and as a consequence we do not have an explicit theory for addressing strategic uncertainty. The implication of this in my view is that most companies face either mediocrity or ruin. As I suggest it's simply because we ignore something doesn't mean it's not there. What I would suggest then is that there is not an underlying prescriptive statement about where you should live in strategic space. If you pursue these extreme positions you will find yourself essentially seeking to maximize your returns. And if you settle for a stuck in the middle position then you're simply minimizing your risk. For those of you who put your finance hat on for a minute this seems perfectly obvious and the notion that you may be surprised to learn that you didn't know there was a trade off between risk and return in strategy. But in fact much of the research that I report in the book is an attempt to demonstrate empirically that this is precisely what we have found. If all we've done then is simply identify this trade off between risk and return can we just be done? Can we deal with the trade off between risk and return? The essence of strategic management deciding where you want to live in the strategic space what risk return trade off is acceptable to you and we'll call it today. Well, I'd like to suggest time. I'm going to give you the reader's diet version of an example over chapter in the book but I would like to talk about Microsoft just briefly. What I'd like to suggest is that Microsoft in fact in its early days was extraordinarily adapted managing precisely strategic uncertainties that derail so many other software firms. What Microsoft was doing, in mind you was creating a very carefully considered portfolio of what I'll call strategic options. They knew where they wanted to compete, they knew that they were all about the operating system business and they knew they wanted to be successful in that space. What they understood is they didn't know how there were material strategic uncertainties. Was it about menu driven interfaces, graphical driven, user facing user interfaces? Was it about complementarity between applications and operating systems? These were critically important strategic areas and so the elements of their portfolio were chosen because they were potentially complementary to each other. Traditionally diversification is about going in different directions that are uncorrelated with each other. What Microsoft had created was a portfolio that was potentially correlated in ways that allowed them to fundamentally change their underlying strategy without sacrificing the need to make commitments in the here and now in order to be successful. In other words, they have created what I call strategic flexibility and that's intended to be an oxymoron, right? Strategies about commitment. Flexibility is about adaptability. How do you commit but remain adaptable? And the portfolio of strategic options is, I think, an answer to that problem. So as a consequence we need a system, we need a macroputor process, we need a framework, something that will make it possible for mere mortals to achieve truly extraordinary results. And the core of that assistant I believe lies in finding a way to separate making strategic commitments from managing strategic uncertainty. And that is what led me director of the organization in the work of La Jax. I was really quite surprised when I started reading about Jax's work that he actually coined the term midlife crisis which I thought was really quite fascinating. And for those of you who were confused if that's your problem this is the wrong conference. Instead it was requisite organization that seemed to me to hold the key solving problems that I was trying to address. Now as a simplified way of thinking about the underlying elements of organization that I'm drawing on assembly. It really is levels of work and time horizons that I'm finding most useful. Things about Time Rising is related to an archetypal hierarchy here's a simplified and I hope not too offensive representation of the underlying framework express both in absolute and relaunched terms. Now I think that a lot of folks because they remain trapped in this notion of strategy as commitment when they think about time horizons and sort of thinking about the short term at the low level versus thinking about longer term, higher level. We'll look at this, we'll accept the guest report. That's precisely what the senior level of the organization is doing. But they're stuck thinking that everybody is making commitments still. And so with consequence, they come to the conclusion, well, the folks down at the bottom are having to commit today to what will work three months from now. And you know what? That's actually fairly straightforward in most instances, and the folks up at the top are having to commit today to what will work ten years from now. And that's enormously difficult. And it's enormously difficult for reasons that were described by jackson. For all of you are explicitly familiar with friends, the notion that it's more ambiguous, that it takes longer to get feedback from the environment, really hard to commit today to what will work ten years from that is the essence of strategic uncertainty. What I'd like to see there is that if we think about time horizons as it relates to the strategic uncertainty we face, there is in fact a fundamentally different strategic balance in each level of the hierarchy that we need to separate ourselves from this notion that strategy is exclusively about commitment. Instead, accept the notion that strategy is about both making commitments and managing uncertainty. At the lower levels, with the shorter time horizons, there is fundamentally less strategic uncertainty because strategy just obtained that fast. Instead, the folks down at the bottom are fundamentally delivering on the commitments that have been made, sometimes years in the past. If you're the marketing man and you're trying to get the cinnamon flavor toothpaste out the door this quarter, you should not be wringing your hands about whether or not you should be in the oral healthcare business at all. It's your job to make the media buy, get the toothpaste on shelves, and sell the stuff you run play. But you're essentially deliberate on commitment, and strategic uncertainty doesn't much depend on what you do. Other types of uncertainty certainly models operational uncertainty, financial uncertainty. Will there be a strike when distributors will price rises go through? How will customers respond to cinnamon flavor toothpaste? These are uncertainties that matter, but they're not strategic uncertainties. As you move up this hierarchy, as you move into the business unit or the operating division side of an organization here, you do in fact, have to make strategic commitments in the face of uncertainty. I can't make the need to commit in order to be successful go away. My view is that everything we know about strategy is true. My criticisms of porter and holland and others are not that somehow they're wrong. Rather, my claim is that it is simply incomplete. The prescription to commit in order to succeed greatly is in fact, correct. And so folks in the middle, right, the folks running, for example, the xbox division inside microsoft, guess what? They have to make commitments to how they are going to succeed in the game console market. They face material strategic uncertainty, right? For example, if you're in the OS division inside Microsoft and five or six years ago, you have to make a commitment to the next generation of the operating system, which came out recently known as MITSUB, you're making a commitment in 2001, 2002 to something that's going to play out over five or six years. What's the strategic uncertainty you're faced with? Well, does the personal computer might actually still be the primary platform for personal computing? Because even in 2000 and 2001, people were looking at the Internet, people were looking at gaming consoles, they were looking at all these other technologies saying, you know what, that's the future of personal computing, not laptop. Well, the OS division had to make a commitment and so they did. They faced the enormous strategic uncertainty, the type I just described. And where did that get managed? Well, that got managed at the very top of the house where they were not making commitments, instead they were managing uncertainty. How did they do that? They created the Xbox division. And so you have a series of individual business units, each of which is making commitment intensive strategies designed to maximize their home success, but inside a portfolio that has been structured in a way that fundamentally reduces the strategic uncertainty faced by each of those divisions. This is not a story whereby if the OS division goes down, oh well, we've got the cash flows from Xbox. The OS division throws out twelve or 13 billion a year in free cash flow. The entire gaming console industry generates less than $12 billion in revenue. So it's not as though they're creating something that will replace the failure or potential failure of some other division. Rather, they are creating divisions that are potentially complementary, so that should the OS division have committed incorrectly to the centrality of the PC six or seven years in the resources and the insight into the requisites in the necessary markets are so available to those divisions so that the underlying strategy can be changed without having underlined the need to commit in the first place. In other words, then the source of value of different operating divisions is different depending on where you are in the hierarchy. When you're right up against the cold face, it's about making plans, selling the cinnamon toothpaste. When you get to the middle of the hierarchy where you're making decisions about competitive strategy, you create value by committing to a particular strategic position. And at the top of the hierarchy, you are generating value by, through the auction value of the portfolio investments that you make. Now, for all of this and all of the work that many of you do with levels of work and time horizons and so forth, how many of you have been in organization where it's not three months, two years, five years, ten years, that's three months three months. Three months. Three months. I was like past observation, right? And in those types of organizations you see a very interesting colony. What you see. This is Charlton Keston from Ben and Her Cherry Racing. What you see is that the CEO which is of course Chuck Heston in the back there basically spend all of their time whipping the horses. They don't think about the long term. They think come on folks, one more lab in the coliseum. Let's make those quarterly numbers. And that I think drives this is the manifestation of the short term pathology that Larry Tappers believe in which is that when organizations are forced to think exclusively about the short term they do not manage the strategic uncertainty they face and simply try and squeeze ever more performance out of individual operating divisions. And the problem therefore is that each operating division is forced to manage the trade off between risk and uncertainty itself. And when does that manifest itself? Divisions dive from the middle of strategic space because the only way they know to make that trade off is to take stuff in the middle strategic positions that allow them to generate acceptable returns at acceptable risk. They're not willing to make the big bets that make extreme success a possibility. Why? Because it could kill them. Neither are they willing to simply go for their own survival because they're held accountable for some modicum of performance. And that's why we see the trade off between risk in return that we describe at the expense. My hope is that by applying the principles of requisite organization in a slightly altered form something that I call requisite uncertainty if you'll forgiveness is that it might be possible now for the levels of an organization to think about what they do in terms of delivering plan, making commitment, creating options in a way that allows individual operating units to make the extreme commitments required for extreme success, but within a context of fundamentally lower risk, thanks to the portfolio of real options created by the CEO of the hierarchy. What that means then is that the CEO is no longer just whipping the horses he is in fact releasing the dub making it possible for operating managers to pursue greatness without courting rules. So that's the light speed version of some of the principles of our uncertainty some of the ideas that are in strategy paradox.