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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

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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.”

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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.

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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 jay.horton@

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.

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