How does a firm choose a competitive strategy when it faces major uncertainties about the future? Oil field suppliers currently are agonizing, for example, over how long the drop in drilling activity will last; the estimates range from less than a year to the rest of the decade. Industry structure is not static, and firms in many industries face considerable uncertainty about how structure will change in the future. The sources of uncertainty are numerous and originate both within the industry and in the industry’s broader environment. Most observers would agree that uncertainty has increased dramatically in the last decade, due to such things as fluctuating raw material prices, swings in financial and currency markets, deregulation, the electronics revolution, and the growth of international competition.
Every firm deals with uncertainty in one way or another. Uncertainty is not often addressed very well in competitive strategy formulation, however. Strategies are frequently based either on the assumption that the past will repeat itself, or on managers’ own implicit forecasts about the most probable future of an industry. Explicit and implicit forecasts of the future structure are often biased by conventional wisdom, and by their very design may average out all the potential uncertainties facing the industry. Managers often fail to consider— or underestimate the probability of—radical or discontinuous changes that might be unlikely but would significantly alter industry structure or a firm’s competitive advantage.
A few firms construct contingency plans as part of the strategic planning process, in an attempt to test strategies against major sources of uncertainty. Contingency planning is rare in practice, however, and usually tests strategies incrementally against only one or two key uncertainties such as the inflation rate or the price of oil. Contingency plans seldom examine alternative future industry structures, or compel managers to consider their implications. When facing considerable uncertainty, firms tend to select strategies that preserve flexibility, despite the costs in terms of required resources or diminished competitive position.
1. Scenarios as a Planning Tool
As the perceived need to address uncertainty explicitly in planning has grown, a few firms have begun to use scenarios as tools to understand the strategic implications of uncertainty more fully. A scenario is an internally consistent view of what the future might turn out to be. By constructing multiple scenarios, a firm can systematically explore the possible consequences of uncertainty for its choice of strategies. The use of scenarios started to become significant after the 1973 oil crisis magnified certain forms of uncertainty.
The scenarios traditionally used in strategic planning have emphasized macroeconomic and macropolitical factors—I refer to these types of scenarios as macroscenarios. Scenario building has concentrated on creating alternative views of the national or global economic and political environment, including such things as the rate of economic growth, inflation, protectionism, regulation, energy prices and interest rates. The use of macroscenarios reflects the fact that oil, natural resources, and aerospace companies were the early leaders in employing scenarios for planning, with Royal Dutch/Shell widely recognized as a pioneer.12 Global macroeconomic and political events can have a profound effect on the success of an international oil or natural resource company. Moreover, scenarios have usually been developed at the corporate level in diversified firms, hence the attention to variables that broadly impact many business units.
Macroscenarios, despite their relevance, are too general to be sufficient for developing strategy in a particular industry. The implications of macroscenarios for individual industries are often poorly understood. Constructing macroscenarios requires the analysis of a broad and highly subjective set of factors. Few aspects of the macroeconomic and political environment have important strategic ramifications for all but the most basic industries. Other uncertainties that macroscenarios leave out such as technological change and competitor behavior can emerge as dominant factors driving industry structural change in particular industries. As a result, macroscenarios have encountered skepticism from many operating managers, and have not become integral to strategic planning in a widespread way.
2. Industry Scenarios
Scenarios are a powerful device for taking acount of uncertainty in making strategic choices. They allow a firm to move away from dangerous, single-point forecasts of the future in instances when the future cannot be predicted. Scenarios can help encourage managers to make their implicit assumptions about the future explicit, and to think beyond the confines of existing conventional wisdom. A firm can then make well-informed choices about how to take the competitive uncertainties it faces into account.
In competitive strategy, the appropriate unit for analysis of scenarios is the industry—I term such scenarios industry scenarios. Industry scenarios allow a firm to translate uncertainty into its strategic implica-tions for a particular industry. By focusing on the industry, macroeconomic, political, technological, and other uncertainties are not analyzed for their own sake but probed for their implications for competition. Industry scenarios also explicitly include competitor behavior, a key source of uncertainty in the choice of strategies.
This chapter describes how to construct industry scenarios, and how to use them to guide the choice of competitive strategy. I begin by describing how to identify the sources of uncertainty facing an industry and how to translate them into the most meaningful industry scenarios. Next, I discuss how to analyze scenarios, and how to identify those with the greatest implications for industry structure and competitive advantage. I then show how a firm can select the best strategy in light of the uncertainties confronting it. The chapter concludes with a discussion of how industry scenarios should fit into a firm’s ongoing strategic planning process.
Source: Porter Michael E. (1998), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press; Illustrated edition.