Having developed and analyzed a set of industry scenarios, the next task is to use them to formulate competitive strategy. Scenarios are not an end in themselves. Many companies falter in translating scenarios into strategy. The bulk of attention is often placed on developing scenarios and not on determining their implications. There is also little guidance in the literature on scenarios about how to use them to formulate strategy.
A firm’s optimal strategy would usually—though not always— be different under each scenario if the firm knew the scenario would occur. Each scenario involves a different industry structure, behaviors of key competitors, and requirements for competitive advantage. Figure 13-8 illustrates this in the chain saw industry, where the strategy for a leading firm is quite different under each scenario.
A firm does not know which scenario will occur, so it must choose the best way to cope with uncertainty in selecting its strategy, given its resources and initial position. The typical prescription for coping with uncertainty is to choose a strategy that is “robust,” or viable regardless of which scenario occurs.5 However, this is by no means the only option. A firm might decide instead to prepare for one scenario despite the risk that it will not occur. Conversely, a firm with massive resources may sometimes be able to pursue the strategies necessary to cope with all scenarios simultaneously and wait for events to unfold before focusing its efforts. If there is uncertainty over the mix of channels, for example, a strong chain saw competitor might develop its position in all likely channels.
A strategy built around one scenario is risky, while a strategy designed to ensure success under all scenarios is expensive. Moreover, the strategies implied by the different scenarios are often contradictory. For example, developing nondealer channels for chain saws will run a high risk of alienating dealers, and it is hard to pursue nondealers and dealers at the same time. In such circumstances, positioning for several scenarios may leave the firm “stuck in the middle” with no competitive advantage, a blurred brand image, and a suboptimal organizational structure (see Chapter 1). The inconsistency of implied strategies under different scenarios often raises a serious strategic dilemma. In chain saws, preparing for all three scenarios would clearly lead to suboptimization, and thus chain saw competitors will have to resolve some difficult tradeoffs before selecting their strategies. One of the important functions of scenarios is to reveal elements of strategy for which a firm must make such choices.
1. Strategic Approaches Under Scenarios
There are five basic approaches to dealing with uncertainty in strategy selection when a firm faces plausible scenarios with differing strategic implications. The approaches can sometimes, though not always, be employed sequentially or in combination.
Figure 13-8. Competitive Strategy Under Alternative Chain Saw Scenarios
- Bet on the most probable scenario. In this approach, the firm designs its strategy around the scenario (or range of scenarios) that is seen to be most probable, accepting the risk that it may not occur. In chain saws, a firm would bet on whichever of the three scenarios it believed to be the most likely.
In practice, betting on the most probable scenario is a common approach to strategy formulation under uncertainty though it is done implicitly. Managers often base their strategies on implicit assumptions about the future. Without becoming explicit, however, a scenario may be based on ignorance and may fail the test of internal consistency so critical to good planning under uncertainty.
The desirability of consciously designing strategy for the most probable scenario depends on how likely it is that the most probable scenario will occur, how adverse the consequences are if other scenarios in fact occur, and how close the fit is between the resources and initial position of the firm and the strategy for dealing with the most probable scenario. The risk of designing strategy around the most probable scenario is that other scenarios will occur which make the strategy inappropriate, and it is difficult to modify the strategy mid-course.
- Bet on the “best” In this approach, a firm designs its strategy for the scenario in which the firm can establish the most sustainable long-run competitive advantage given its initial position and resources. This approach seeks the highest upside potential by tuning the strategy to the possible future industry structure that yields the best outcome for the firm. The risk, of course, is that the best scenario does not occur and the chosen strategy is thereby inappropriate.
- In this approach, a firm chooses a strategy that produces satisfactory results under all scenarios, or at least under all scenarios that are deemed to have an appreciable probability of occurring. This is one approach to designing a robust strategy. The idea is similar to the “minimax” strategy in game theory, where a player makes the move that minimizes his maximum loss. In chain saws, hedging might entail developing a very wide model line, or entering nondealer channels with slightly different models sold under a different brand name at the same time as the firm continued to serve dealers.
Usually hedging will yield a strategy that is not optimal for any scenario. The resulting sacrifice in strategic position is traded off in favor of a reduction in risk. Moreover, hedging usually implies higher costs (or lower revenues) than a betting strategy because it must prepare a firm for several different possible competitive circumstances rather than one.
- Preserve Another approach to dealing with uncertain scenarios is to choose a strategy that preserves flexibility until it becomes more apparent which scenario will actually occur. This is another way of creating a robust strategy and illustrates that robustness must be carefully defined. The firm postpones resource commitments that lock it into a particular strategy. Once the uncertainties begin to resolve themselves, a strategy that fits the scenario that appears to be occurring is chosen, taking into account the firm’s resources and skills. In chain saws, flexibility might be preserved by maintaining the firm’s strategy in the professional segment and sourcing casual user saws initially from another firm.
A firm preserving flexibility often pays a price in strategic position because of first-mover advantages gained by firms that commit early. First- mover advantages—e.g., reputation, a proprietary learning curve, and ability to tie up the best retail channels—were discussed in detail in Chapter 5. In chain saws, the firm that moves into new channels first may well get its pick of the best ones. Preserving flexibility sacrifices first-mover advantages in return for a reduction in risk. It is different from hedging because it involves delaying commitment, rather than embarking on a strategy that works reasonably well under all feasible scenarios. If a firm can recognize early which scenario is going to occur, it can minimize the cost of preserving flexibility.
- In the final approach to addressing uncertainty, a firm attempts to use its resources to bring about a scenario that it considers desirable. A firm seeks to raise the odds that a scenario will occur for which it has a competitive advantage. Doing so requires that a firm try to influence the causal factors behind the scenario variables. Since a causal factor in casual user demand for chain saws is woodburning stove installations, for example, a firm might try to influence stove demand. This might involve coalitions with woodburning stove manufacturers, or advertising that stressed the value of woodburning stoves at the same time that it advertised chain saws. Technological changes, channel policies, government regulation, and many other sources of uncertainty can sometimes be influenced. The possibility for influence and its cost must be weighed against the competitive advantage to be gained if a firm can raise the odds that its preferred scenario will occur.
2. Combined and Sequenced Strategies
It is often possible and desirable to employ combined and sequential strategies. Betting on the most probable or best scenario can be combined with attempting to influence which scenario occurs. Similarly, the approach of preserving flexibility is logically part of a sequential strategy that ultimately involves a bet on the most probable scenario. A firm can also choose to hedge initially and then bet on a future industry structure as the actual scenario becomes clearer, though this is usually more costly than preserving flexibility and then betting.
A firm may also be able to set policies in some activities in the value chain to bet on a scenario, while hedging or preserving flexibility in others. In chain saws, for example, a firm might bet on high casual demand in its manufacturing and technology development activities through building new low-cost facilities and designing several inexpensive, lightweight models. At the same time, though, it could hedge its bet by minimizing the level of vertical integration in manufacturing to reduce capital investment and thereby transfer some of the risk to suppliers. It could also hedge its bets by spending heavily on marketing and sales activities to maintain dealer relations and preserve market position in the professional and farm segment.
A firm may also choose to contain risk in another way, by committing early to reversible actions (advertising) while postponing commitments on irreversible investments (e.g., plants). Any form of avoiding commitments or hedging will usually involve some sacrifice in competitive advantage, though, and may also be confusing to both employees and outside observers such as security analysts.
3. The Choice of Strategy Under Industry Scenarios
Each of the ways of coping with uncertain industry structural change has its potential benefits, costs, and risks in terms of competitive advantage. The following factors are most important in choosing a firm’s approach:
First-mover Advantages. The size of first-mover advantages (Chapter 5) has a major influence on the attractiveness of betting versus postponing commitments. Where the first mover gains a significant competitive advantage, for example, the option of flexibility may be ruled out. In chain saws, gaining access to new channels may well involve significant first-mover advantages, because many mass merchandisers are unlikely to carry multiple lines of saws.
Initial Competitive Position. Scenarios will differ in their potential for a firm given its initial competitive position. Designing a strategy for the scenario that fits a firm’s initial position may produce a significantly better outcome than designing a strategy around the most probable scenario. This difference in performance may compensate for the risk of betting on a less probable scenario. Influencing which scenario occurs is an attempt to shift probabilities in the direction of the scenario where a firm has the most advantages.
Cost or Resources Required. Hedging and influence tend to require greater resources or imply higher costs than does betting on one scenario. Preserving flexibility is usually somewhere in between.
Risk. The risk of each approach is a function of a number of factors:
TIMING OF RESOURCE COMMITMENT. Early commitment is usually riskier than later commitment. Preserving flexibility minimizes risk by postponing commitment, while hedging seeks to reduce risk in a different way. How long the firm can delay its commitment depends on first-mover advantages and the lead time in making moves.
THE DEGREE OF INCONSISTENCY OF STRATEGIES FOR ALTERNATE SCENARIOS. Risk is a function of how poorly a strategy will perform if the “wrong” scenario occurs. Hedging minimizes this risk at the price of higher costs or poorer position. The degree of inconsistency among strategies for alternate scenarios is a function of how different industry structure and the sources of competitive advantage are under each scenario.
RELATIVE PROBABILITY OF THE SCENARIOS. The choice of approaches depends on the relative probability of the scenarios. Hedging is a way to deal with risk by reducing the exposure of a firm to any scenario, while influence seeks to reduce risk by shifting probabilities toward the desired scenario. Betting on the most probable scenario is more risky than hedging, while betting on the best scenario can be the most risky approach.
THE COST OF CHANGING STRATEGIES ONCE UNCERTAINTY IS RESOLVED. Risk depends on the degree to which a firm is locked in once it commits to a strategy by setting its product line, channels, advertising policies, facilities, and so on. This will depend on the degree of irreversibility of the required investments, which will differ from industry to industry and strategy to strategy. Preserving flexibility seeks to minimize the cost of changing strategies.
Competitors’ Expected Choices. A firm’s choice of how to deal with uncertainty must reflect the choices its competitors have made or are expected to make. Competitor bets may preempt a firm from certain strategies and open up others. Hedging or preserving flexibility by competitors usually raises the payoff to the firm that makes a bet that proves correct.
The best way to deal with uncertainty is to make a conscious choice to follow one or more approaches, rather than a choice based on inertia or an implicit scenario. Weighing the factors involved in choosing an approach described above requires a logic for each scenario that portrays the interdependencies between various aspects of industry structure. The most challenging part of dealing with uncertainty is to find creative ways to minimize the cost of preserving flexibility or hedging, and to maximize the advantages of betting correctly. Understanding the way in which each activity in the value chain can contribute to competitive advantage under the various scenarios may allow the firm to do so.
4. Scenario Variables and Market Intelligence
Which scenarios will occur is determined by the scenario variables. Scenario variables are thus key indicators of the path of industry structural change—they can become clear quickly or the uncertainty may persist for long periods. Scenario variables and their causal factors should be the focal point for gathering market intelligence. Changes affecting scenario variables are warning signals of industry structural change. A firm preserving flexibility, for example, will want to closely monitor the state of scenario variables to decide when to commit.
Early information about the future state of scenario variables has a high strategic value. The earlier a firm can confidently predict the occurrence of a particular scenario, the sooner it can commit to a strategy with the accompanying gains in position described above. Thus investments in information gathering should concentrate on scenario variables rather than on indiscriminate tracking of the myriad other changes that accompany industry evolution.
Good information on scenario variables is also extremely valuable at the time when industry scenarios are constructed. Since the scenario variables are essential to structural change, understanding them may improve the set of scenarios investigated or even turn what initially appear to be scenario variables into predetermined elements of structure. In chain saws, for example, good data about household formation, the number of dwellings with fireplaces and other causal factors could reduce the range of assumptions that had to be made about casual user demand.
Source: Porter Michael E. (1998), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press; Illustrated edition.