sTRATEgY 2.0 · iMac -> iPhone -> iPad — is a case in point. Through the iPod and iTunes, Apple...

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MHD SUPPLY CHAIN SOLUTIONS MARCH / APRIL 2010 SUPPLY CHAIN 56 56 JAY HORTON STRATEGY 2.0: INNOVATING HOW WE DEVELOP AND EXECUTE STRATEGY ‘R eady, aim, fire.’ In the traditional model of strategy, you set a clear objective, predict the future outcomes of strategic moves, and then set the controls for executing the selected decisions. But when markets are emerging, colliding, splitting or dying, this traditional model doesn’t work very well. The problem is the increasing difficulty of predicting outcomes in a world of faster, broader and uncertain change. Recent work on firms’ competitive perfor- mance confirms what many of us already know. Competitive advantage has become harder to sustain across a broad range of industries. A broad, relentless shift is underway, towards a new, more dynamic form of competition called hyper-competition. In a hyper-competitive market, sustained competitive advantage is not a matter of a single advantage maintained over time, but more a matter of a sequence of advantages inter-linked over time. For example, Apple’s sequence of moves — iTunes -> iPod -> iMac -> iPhone -> iPad — is a case in point. Through the iPod and iTunes, Apple has been able to break out of the barriers imposed by its unique proprietary operating system and attack the much larger commu- nity of Microsoft customers by moving into the markets for music. In this hyper-competitive, dynamic world a new toolset is needed. We call this toolset Strategy 2.0. Its aim is to enable firms to develop and execute strategy in a fast-moving, uncertain environment. Strategy 2.0 involves shifts in the way we think about strategy: From ‘strategic positioning’ to developing ‘dynamic capabilities’, facilitating adaptation and capture of new opportunities. From emphasising ‘prediction and control’ to ‘sense-making’, favouring actions that are informative and exploratory. From making ‘big bets’ on the future to creating ‘real options’, opening up new choices in an uncertain world. Let’s look at each of these fundamental shifts. From ‘strategic positioning’ to developing ‘dynamic capabilities’ The traditional view of strategy focuses on how to build a good position. Based on the well-known ‘five-forces’ framework of Michael Porter, competitive advantage comes from actions taken by a firm to create defensible positions against competitors - for example, by erecting strong barriers to entry. In this framing, the strategic problem faced by managers is one of making markets work less efficiently - to the company’s advantage. This is no longer an easy route in a ‘flat world’ of smart, orchestrated networks of firms that do not need huge capitalisation to compete. In a second framework, the resource-based view of strategy, competitive advantage comes from difficult-to-imitate firm-specific assets that can be used to capture rents — for instance, through strong intellectual property, or a dominant brand. In this view, profits flow from having lower costs or higher quality (e.g. through efficient supply chains or operational excellence), innovative products, or customer insight that allows firms to understand and meet customer needs in the way competitors cannot. Both of these perspectives are largely static and emphasise how firms compete at a single point in time. The new strategic framework of dynamic capabilities builds on the notion of core competencies but focuses on building and adapting these competencies to address rapidly changing environments. This develop- ment was stimulated by the recognition that many successful or dominant firms fail to sustain their performance as markets and technologies shift (think Ansett, the former Coles-Myer, or General Motors). In spite of having the resources, these companies failed to adapt to changed circumstances. Dynamic capabilities are the routines, activities and micro-processes by which an organisation achieves a new configuration. Their intent is to generate and modify the company’s operational routines to thrive in a dynamic business environment. Early warning systems, fault tolerance, flexibility and modularity in products and processes One example of a ‘must-have’ dynamic capability is the ability to identify and capture opportunities more quickly than rivals. The logic behind an early-warning
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Transcript of sTRATEgY 2.0 · iMac -> iPhone -> iPad — is a case in point. Through the iPod and iTunes, Apple...

  • MHD Supply Chain SolutionS — marCh / april 2010

    sUppLY CHAin56

    56

    JAY HoRTon

    sTRATEgY 2.0:innovating how we Develop anD exeCute Strategy

    ‘Ready, aim, fire.’ In the traditional model of strategy, you set a clear objective, predict the future outcomes of strategic moves, and then set the

    controls for executing the selected decisions.

    But when markets are emerging, colliding,

    splitting or dying, this traditional model doesn’t

    work very well. The problem is the increasing

    difficulty of predicting outcomes in a world of

    faster, broader and uncertain change.

    Recent work on firms’ competitive perfor-

    mance confirms what many of us already

    know. Competitive advantage has become

    harder to sustain across a broad range

    of industries. A broad, relentless shift is

    underway, towards a new, more dynamic form

    of competition called hyper-competition.

    In a hyper-competitive market, sustained

    competitive advantage is not a matter of a

    single advantage maintained over time, but

    more a matter of a sequence of advantages

    inter-linked over time. For example, Apple’s

    sequence of moves — iTunes -> iPod ->

    iMac -> iPhone -> iPad — is a case in

    point. Through the iPod and iTunes, Apple

    has been able to break out of the barriers

    imposed by its unique proprietary operating

    system and attack the much larger commu-

    nity of Microsoft customers by moving into

    the markets for music.

    In this hyper-competitive, dynamic world

    a new toolset is needed. We call this toolset

    Strategy 2.0. Its aim is to enable firms to

    develop and execute strategy in a fast-moving,

    uncertain environment. Strategy 2.0 involves

    shifts in the way we think about strategy:

    From ‘strategic positioning’ to developing

    ‘dynamic capabilities’, facilitating adaptation

    and capture of new opportunities.

    From emphasising ‘prediction and control’

    to ‘sense-making’, favouring actions that are

    informative and exploratory.

    From making ‘big bets’ on the future

    to creating ‘real options’, opening up new

    choices in an uncertain world.

    Let’s look at each of these fundamental shifts.

    From ‘strategic positioning’ to developing ‘dynamic capabilities’The traditional view of strategy focuses on

    how to build a good position. Based on the

    well-known ‘five-forces’ framework of Michael

    Porter, competitive advantage comes from

    actions taken by a firm to create defensible

    positions against competitors - for example,

    by erecting strong barriers to entry. In this

    framing, the strategic problem faced by

    managers is one of making markets work less

    efficiently - to the company’s advantage. This

    is no longer an easy route in a ‘flat world’ of

    smart, orchestrated networks of firms that do

    not need huge capitalisation to compete.

    In a second framework, the resource-based

    view of strategy, competitive advantage comes

    from difficult-to-imitate firm-specific assets

    that can be used to capture rents — for

    instance, through strong intellectual property,

    or a dominant brand. In this view, profits flow

    from having lower costs or higher quality (e.g.

    through efficient supply chains or operational

    excellence), innovative products, or customer

    insight that allows firms to understand and

    meet customer needs in the way competitors

    cannot. Both of these perspectives are largely

    static and emphasise how firms compete at a

    single point in time.

    The new strategic framework of dynamic

    capabilities builds on the notion of core

    competencies but focuses on building and

    adapting these competencies to address

    rapidly changing environments. This develop-

    ment was stimulated by the recognition that

    many successful or dominant firms fail to

    sustain their performance as markets and

    technologies shift (think Ansett, the former

    Coles-Myer, or General Motors). In spite of

    having the resources, these companies failed

    to adapt to changed circumstances.

    Dynamic capabilities are the routines,

    activities and micro-processes by which an

    organisation achieves a new configuration.

    Their intent is to generate and modify the

    company’s operational routines to thrive in a

    dynamic business environment.

    Early warning systems, fault tolerance, flexibility and modularity in products and processesOne example of a ‘must-have’ dynamic

    capability is the ability to identify and

    capture opportunities more quickly than

    rivals. The logic behind an early-warning

    MHD MarchApril10 46-84.indd 56 16/02/10 3:21 PM

  • MHD Supply Chain SolutionS — marCh / april 2010 57

    sUppLY CHAin 57

    system is compelling. It is a form of insurance.

    Without regularly monitoring the signals that

    come from an early warning system, compa-

    nies are actually increasing their vulnerabili-

    ties. What has not been foreseen is unlikely to

    be seen in time.

    Other must-have capabilities include the

    ability to rapidly create new products and pro-

    cesses in response to changing market opportu-

    nities. In marketing and R&D it is a willingness

    to cannibalise, entertain constructive conflict,

    tolerate failure, and cut some slack in the avail-

    ability of resources.

    In manufacturing and service operations, it

    is the “plug and play” or modular product and

    process architectures that are key enablers

    of strategic flexibility. Modularity is created by

    decomposing a product or process design into

    relatively independent components, and by

    specifying standard interfaces that define the

    inputs and outputs that flow between interact-

    ing components.

    By exploiting modularity you may be able to

    change the competitive game. For example,

    the modular structure of the personal computer

    made it possible for Michael Dell and others to

    begin selling PCs to order, by assembling them

    like Lego from a set of standardised components.

    From emphasising ‘prediction and control’ to ‘sense-making’Intelligence in a low-predictability environment

    Quantitative forecasting – such as with econo-

    metric and financial risk modelling – does not

    perform well in an uncertain environment, since

    the assumptions and structure of such models

    are derived from past history. And history can

    be a very imperfect guide to the future.

    Risk is present when future events occur

    with measurable probability. But uncertainty is

    present when the likelihood of future events is

    incalculable. Mistaking risk for uncertainty has

    been singled out as a major contributor to the

    global financial crisis.

    Mr Greenspan described risk management in

    2002: “The use of a growing array of derivatives

    and the related application of more sophisti-

    cated methods for measuring and managing

    risk are key factors underpinning the enhanced

    resilience of our largest financial institutions. As

    a result, not only have individual financial insti-

    tutions become less vulnerable to shocks from

    underlying risk factors, but also the financial

    system as a whole has become more stable.”

    That must rank high among observations the

    speaker wishes he had not made.

    Possibly the most important feature of a

    strategy is that it must present a coherent

    view about the forces at work and how best to

    respond. When there are high levels of ambigu-

    ity, complexity or unpredictability in the business

    environment, strategy must be discovery driven,

    involve exploration and learning using qualitative

    methods, rather than simply being a quantitative

    spreadsheet-driven approach.

    This discovery-driven approach involves three

    challenges of imagination:

    • The challenge of identifying the range of

    future developments in markets, technologies,

    the natural environment, politics and society.

    • The challenge of determining how those future

    developments will affect the company.

    • The challenge of determining the impact of

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    sTRATEgY 2.0:innovating how we Develop anD exeCute Strategy “Entrepreneurs are the masters of sense-making.

    Their skill is finding opportunity in the midst of turbulence, to spot and seize major opportunities when they arise.”

    MHD MarchApril10 46-84.indd 57 16/02/10 3:21 PM

  • MHD Supply Chain SolutionS — marCh / april 2010

    sUppLY CHAin58

    58

    the company’s actions in response to future

    developments.

    To meet these challenges, sense-making is

    the art of discovering the new terrain as you are

    inventing it by:

    • Seeking many types and sources of data,

    and involving a broad range of expertise

    from inside and outside the company in your

    sense-making.

    • Not simply applying existing frameworks and

    overlaying them on the situation, but moving

    beyond current stereotypes.

    • Performing experiments to obtain potentially

    valuable new knowledge.

    • Using scenarios to capture and communicate

    critical issues.

    Scenario planning as a sense-making framework

    Scenarios are plausible, compelling yet surprising

    stories that describe how the future might pan

    out. They weave together changes in technolo-

    gies, markets, politics, social values and drivers

    of change in the form of a ‘storyline’. Scenarios

    are not predictions, nor options from which a pre-

    ferred choice should be made. Rather, they are

    examples distilled from many possible futures.

    They serve to challenge preconceptions about

    the future. The natural inclination of managers

    is to work from what is known. Scenarios force

    us to look at what is not very well-known, and

    what cannot be controlled.

    The essence of the scenario process is that

    you research emerging developments. You deter-

    mine which are predictable, which are uncertain,

    and which uncertainties are most influential.

    You base the scenarios of the future on those

    uncertainties, and spend time understanding the

    implications of those scenarios. Figure 1 shows

    the two main phases in scenario planning:

    building scenarios and using scenarios.

    Thinking entrepreneurially using scenarios

    Entrepreneurs are the masters of sense-making.

    Their skill is finding opportunity in the midst of

    turbulence, to spot and seize major opportuni-

    ties when they arise. Turbulent markets typically

    produce a steady flow of small opportunities,

    intermittent midsize ones, and periodic golden

    opportunities to create significant value.

    Once scenarios have been crafted, the

    strategy development begins: testing the

    company’s strategic options against the sce-

    narios, addressing the following questions.

    What should the company be doing under

    each scenario? What actions are common to

    all scenarios—the “no regrets” strategy? What

    actions work under one scenario, but are very

    risky under another scenario? What is the

    essence of the organisation’s success, given

    the range of scenarios?

    The scenarios are used to develop the port-

    folio of initiatives to address the challenges and

    the opportunities. These initiatives might include

    the following:

    • New capabilities which are needed, and existing

    capabilities which need to be revamped.

    • Initiatives to increase flexibility and speed of

    adaptation.

    • Changes in the nature of the dialogue between

    key stakeholders – customers, investors,

    policy makers, regulators, and so on.

    • Formation of new alliances and partnerships.

    • Decisions on ‘real option’ investments that build

    robustness against the range of scenarios.

    From making ‘big bets’ on the future to

    creating ‘real options’

    In developing strategy under uncertainty,

    companies face two economic tradeoffs when

    making large, irreversible investments:

    Acting early versus acting later after the

    uncertainty is resolved, and

    Focusing resources on one scenario versus

    spreading resources to address several scenari-

    os and so build resilience and flexibility.

    Messy, ambiguous, uncertain and complex business outlook

    DivergenceExploring difference multiple perspectives.

    ConvergenceSearch based on imagination and disciplined analysis.

    Strategic Outcomes• Changed thinking.• Informed narative

    about possible futures.• Improved organisational

    decision making.• Enhanced human and

    organisational learning and foresight.

    BUILDINGSCENARIOS

    USINGSCENARIOS

    Figure 1.

    MHD MarchApril10 46-84.indd 58 16/02/10 3:21 PM

  • MHD Supply Chain SolutionS — marCh / april 2010 59

    sUppLY CHAin 59

    To solve these issues, the analytical frame-

    work of ‘real options’ is applied.

    Real options logic has an intuitive sense. It

    advises to move forward in stages when steering

    investments through uncharted waters: consider

    a variety of future scenarios and potential strate-

    gies; favour flexible actions that are robust to

    uncertainties; favour actions that yield useful

    information; probe, experiment and learn through

    doing; monitor and adapt to changing conditions.

    The real options framework explicitly recog-

    nises that management always has the power to

    change strategy in response to changing condi-

    tions. They use levers such as: accelerate or

    defer, ‘make or buy’, switch markets, expand or

    contract, and so on.

    Value is created through identifying, creating,

    owning, managing, and exercising options such

    as the following:

    Planting seeds: Experiment strategically by

    making a series of small investments, before

    making the big ones;

    Learning actively: Decisions on a program do

    not always have to be made up front; conduct

    tests and capitalise on learnings;

    Building on-ramps and off-ramps: Embed

    options to defer or accelerate, to switch direc-

    tion at any stage.

    Figure 2. illustrates a decision tree for a

    two-stage investment decision, the simplest

    form of real option.

    By breaking decisions into stages, execu-

    tives can build flexibility into their plans. When

    building a new plant, for example, it may be

    tempting to realise the full economies of scale

    by building the biggest facility the company

    can manage. But it may be wiser to first build a

    smaller plant that can be easily expanded later

    on. That way, if the market for the products the

    plant produces does not emerge as expected, a

    smaller investment has been put at risk. At that

    point, managers have the option to scale down

    or abandon operations. On the other hand, if

    things turn out well, they have the option to

    expand the plant.

    With increased volatility in the business envi-

    ronment, real options actually become more

    valuable, so companies should be willing to pay

    for flexibility.

    A recent study of Korean manufacturing export

    firms demonstrated that companies with real

    option-type investments – operating both off-

    shore and on-shore facilities – benefited through

    having flexibility during the economic downturn,

    in contrast to firms without such investments.

    ConclusionIf traditional strategy no longer works in a world

    of faster, broader and uncertain change, then

    neither does fire fighting, buzz-following and

    similar myopic approaches.

    To succeed in the years of dramatic change

    ahead companies will benefit from the methods

    of Strategy 2.0.

    Develop sense-making skills such as scenario

    planning to probe a messy, complex and uncer-

    tain market and business environment. Reduce

    the reliance on forecasts for making decisions;

    for example by shrinking lead times. Use real-

    option based reasoning to build flexibility into

    investment programs. Build new capabilities

    that facilitate responsiveness, experimentation

    and capture of new opportunities.

    Play the game like an entrepreneur would

    play. A talent for seeing things differently, rather

    than competing head-to-head, is now the chief

    instrument of strategic advantage.

    Jay Horton is the founder and managing

    director of Strategis Partners, and a leading

    adviser to companies and governments in Asia

    and Australia on strategic management issues,

    including scenario planning, capital investment

    decision making and real options analysis, and

    corporate strategy. Contact Jay at [email protected]

    strategispartners.com.au or visit www.strat-

    egispartners.com.au.

    YES

    YES

    GOOD NEWS

    BAD NEWS

    NO

    NO

    PHASE 1Investment Decision / Project Performance

    PHASE 2Investment Decision

    Figure 2.

    MHD MarchApril10 46-84.indd 59 16/02/10 3:21 PM