Levels of Uncertainty

CIO Insight: Your approach is to break down uncertainties into different levels, and then apply certain tools. Can you describe these tools?

Courtney: It depends on the type and level of uncertainty face. Do you face a discrete set of possible outcomes? Examples would be if the primary source of uncertainty is whether a competitor will match your price or build a plant or not, or whether a pending regulatory or legislative policy will take effect, or whether one technology standard will replace another.

The types of tools that tend to work quite well here are a class of tools or decision analysis tools that are about probabilistic decision-making—trying to understand, even if you can't precisely quantify them, the relative probabilities, the relative likelihoods of the different outcomes, then assessing strategies against those potential outcomes. Which sorts of strategies, for instance, are robust, will pay off regardless of scenario? Which ones are more like big bets on one scenario or another, and what can you do to hedge those bets? Some traditional planning tools work well. Game theory is particularly helpful when you face competitive conduct uncertainty, when one of those uncertainties is how a competitor or even a supplier or customer will react.

In other types of uncertainty, which I call Level 2, you can only bound a very broad range of outcomes. Scenario planning has been used successfully for that type of broad range of uncertainty. However, what it can't do is place probabilities on outcomes. It can't do quantitative risk return analyses. Instead, scenario planners tend to use the range of potential scenarios to qualitatively test robustness, test what strategies are big bets and what's the worst potential outcome. Level 3 tools are quite similar but used in different ways. And a short way to think about the difference is that Level 2 can be more quantitative. In level 3 it starts to get a bit more qualitative, yet still quite systematic.

And then, finally, Level 4 situations are those where no matter how good your analysis, how thorough it is, there's just no way that one can bound the range of outcomes. So scenarios don't make sense, because who knows whether the scenarios are representative at all or whether they cover the range of outcomes? What most strategies do is work forward from analysis to conclusion. You say, OK, here's what the industry looks like. In fact, it will support a price point of $5 per widget, and we have a cost structure that is $3 per widget. And so we can make $2 per widget, so it's worth investing $10 million in that market.

In Level 4 situations, you don't know the price of widgets, and you can't even bound the range of outcomes. You don't know what the competitive response will be, and again, there really is no good analysis you can do to bound it. Instead you have to just work backwards from the potential solution to at least a set of assumptions. For instance, you want to invest $25 million in an unproven genomics area, where no matter how good your analysis is, you're just not going to be able to bound the commercial applicability of that area. You just don't know yet.

What you could do, though, is work backwards and say, OK, to support a $25 million investment today, you would have to believe that a commercially viable drug will get to market within X number of years, that it will have a potential patient treatment size of Y people, that the marketing dollars to bring the drug to bear will be less than or equal to Z dollars, etc. In other words, develop a scenario that would say this is what you would have to believe at the very least to support that $25 million investment.

Then at the very least what you could do is test industry analogies, case studies, etc., to try to see, for instance, whether this has to be the most successful drug launch ever in history to support a $25 million investment. At the very least you could, first of all, be very explicit about the assumptions, bring to bear some information from analogy and other case studies to assess those assumptions, and then make a more informed decision.

So there's no way that analysis can tell you that you're going to make 25 percent return on assets on the investment, nor will it even be able to bound the range of outcomes. But it would at least allow you to systematically assess the underlying assumptions that are implicit in the strategies you're looking at, and thus allow for more informed decisions.

CIO Insight:Of all the factors that have to be taken into account in the strategic plan—the competitors, customers, markets, whatever—is there any one of those that is more affected by Sept. 11 than the others?

Courtney:: Certainly I think geography is an issue, and for a multinational corporation in particular location security within that location is increasingly important. For instance, people may think twice or more than twice about investments in Indonesia today relative to what they were thinking about a couple of years ago, or anything in the Southeast Asia area. And, of course, obviously, the Middle East.

But I think the security issue first and foremost is around employees, then, of course, assets. You don't want plants being blown up. But it's actually much more subtle in that more and more people are thinking about institutional security, different political and economic regimes in different areas of the world. They're thinking more about security of their value chains, supply chains so that, OK, we're in a safe country, but actually all of our material comes from Indonesia. How do I think about that?

So the greater macropolitical economy issues are ones that more and more companies are addressing today, along with the fundamental economic institutions, the legal structures, the threat of political and social upheaval and unrest.

CIO Insight:What is the first priority for a company trying to make strategy in this era?

Courtney:: Well, the first priority is to calm down, forget the hype and do what you've always done best, which is to systematically understand what creates and captures value in your industry. And most companies will find that the majority of those value drivers are still the important ones, and if it was important to be cost leader in your industry pre-Sept. 11, it certainly still is, and you better focus on that. If differentiating product and service strategies are what drive your niche, then that's probably still the case, and so on. You shouldn't lose focus of those things.

On top of that, for some companies, some industries, there's going to be significant new uncertainties that they're going to have to address. But I would say they don't require a crystal ball, they don't require information that's not potentially available out there. It's just that you have to be systematically thoughtful about it.

And I know it sounds almost sterile, but the fact of the matter is we all felt an incredibly personal kind of horrific shock felt after Sept. 11, and some companies are facing almost horrific challenges today, but systematic, thoughtful management and leadership is the answer now more than ever.