Industry scenarios and competitive strategy of the firm

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. M any companies  falter in translating scenarios into strategy. The bulk of attention  is often placed on develop­ ing 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 i f 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 chan­ nels, 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 orga­ nizational structure (see Chapter 1). The  inconsistency of implied strategies under different scenarios often raises a serious strategic di­ lemma. 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 al­ ways, be employed sequentially or in combination.

Figure   13-8.    Competitive Strategy   Under Alternative Chain   Saw   Scenarios

  1. Bet on the most probable 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. W ithout  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.

  1. Bet on the   “best” scenario.   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 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 inappropri­ ate.
  1. In this approach, a firm chooses a strategy that pro­ duces satisfactory results under  all scenarios, or at least under  all scenarios that are deemed to have an appreciable probability of occur­ ring. 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.

  1. Another approach to dealing with uncertain scenarios is to choose a strategy that preserves flexibility until it be­ comes more apparent  which scenario will actually occur. This  is an­ other 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 sacri­ fices 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.

  1. 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 woodburn­ ing stove manufacturers, or advertising that stressed the value of wood- burning 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 m ust be weighed against the com­ petitive 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 sequen­ tial strategies. Betting on the most probable or best scenario can be combined with attempting  to influence which scenario occurs.   Simi­ larly, the approach of preserving flexibility is logically part of a sequen­ tial 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 inexpen­ sive,   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 market­ ing 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 commit­ ting early to reversible actions (advertising) while postponing commit­ ments on irreversible investments (e.g., plants). Any form of avoiding commitments or hedging will usually involve some sacrifice in competi­ tive 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  im portant  in choosing a firm’s approach:

First-mover Advantages. The  size of first-mover advantages (Chapter 5) has a m ajor  influence on the attractiveness  of betting versus postponing commitments. W here the first mover gains a signifi­ cant  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 mer­ chandisers are unlikely to carry multiple lines of saws.

Initial Competitive Position.      Scenarios will differ in their poten­ tial for a firm given its initial competitive position. Designing a strategy for the scenario that fits a firm’s initial position may produce a signifi­ cantly better outcome than designing a strategy  around the most proba­ ble scenario. This  difference in performance  may compensate  for the risk of betting on a less probable scenario. Influencing which scenario occurs is an attem pt 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 re­ quire 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 usu­ ally 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   ALTER­-NATE 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 inconsis­ tency 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 ap­ proaches 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. Under­ standing the way in which each activity in the value chain can contrib­ ute to competitive advantage  under  the   various scenarios   may   allow the firm to do so.

4. Scenario Variables and   M arket  Intelligence

Which scenarios will occur is determined by the scenario variables. Scenario variables are thus key indicators of the path of industry struc­ tural 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 sce­ nario 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 struc­ ture. 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.

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