Tuesday, February 03, 2009

Leading through uncertainty
The range of possible futures confronting business is great. Companies that nurture flexibility, awareness, and resiliency are more likely to survive the crisis, and even to prosper.
DECEMBER 2008 • Lowell Bryan and Diana Farrell

This is a great summary of how to manage in these highly uncertain times and is a continuation from the January 27 posting (http://marketdrivengrowth.blogspot.com/2009/01/fresh-look-at-strategy-under.html)

What we don’t know

Yet there is much that we don’t know, and won’t for some time: how well will governments work together to develop effective regulatory, trade, fiscal, and monetary policies; what will these responses mean for the long-term health of the global capital market; how will its health or weakness influence the pace and extent of change in areas such as the economic role of government, financial leverage, and business models; and what will all this imply for globalization and economic growth?
Although these questions won’t be answered in the short or even the medium term, decisions made in the immediate future are critical, for they will influence how well organizations manage themselves now and compete over the longer haul. The winners will be companies that make thoughtful choices—despite the complexity, confusion, and uncertainty—by assessing alternative scenarios honestly, considering their implications, and preparing accordingly.

In particular, organizations must think expansively about the possibilities. Even in more normal times, the range of outcomes most companies consider is too narrow. The assumptions used for budgeting and business planning are often modest variations on baseline projections whose major assumptions often are not presented explicitly. Many such budgets and plans are soon overtaken by events. In good times, that matters little because companies continually adapt to the environment, and budgets usually build in conservative assumptions so managers can beat their numbers.
But these are not normal times: the range of potential outcomes—the uncertainty surrounding the global credit crisis and the global recession—is so large that many companies may not survive. We can capture this wide range of outcomes in four scenarios (exhibit).

(go to the web site for a clearer picture)

To see them in perspective, consider some results of the McKinsey Global Institute’s research. This research, focusing on the United States, the center of the storm, suggests that if capital markets rebound quickly, GDP would be 2.9 percentage points lower than it would have been if trend growth had continued over the next two years. If financial markets take longer to recover, as the middle two scenarios envision, US GDP growth could fall 4.7 to 6.7 percentage points from trend over the same period. At the “long freeze” end of the spectrum, Japan’s “lost decade” shaved 18 percentage points from GDP compared with its previous growth trend.

Regenerated global momentum
In the most optimistic scenario, government action revives the global credit system—the massive stimulus packages and aggressive monetary policies already adopted keep the global recession from lasting very long or being very deep. Globalization stays on course: trade and capital flows resume quickly, and the developed and emerging economies continue to integrate as confidence rebounds quickly.

Battered but resilient
In the second scenario, government-wrought improvements in the global credit and capital market are more than offset—for 18 months or more—by the impact of the global recession, which leads to further credit losses and to distrust of cross-border counterparties. Although the recession could be longer and deeper than any in the past 70 years, government action works, and the global capital and credit markets gradually recover. Global confidence, though shaken, does rebound, and trade and capital flows revive moderately. Globalization slowly gets back on course.

Stalled globalization
In the third scenario, the global recession is significant, but its intensity varies greatly from nation to nation—in particular, China and the United States prove surprisingly resilient. The integration of the world’s economies, however, stalls as continuing fear of counterparties makes the global capital market less integrated. Trade flows and capital flows decline and then stagnate. The regulatory regime holds the system together, but various governments overregulate lending and risk, so the world’s banking system becomes “oversafe.” Credit remains expensive and hard to get. As attitudes become more defensive and nationalistic, growth is relatively slow.

The long freeze
Under the final scenario, the global recession lasts more than five years (as Japan’s did in the 1990s) because of ineffective regulatory, fiscal, and monetary policy. Economies everywhere stagnate; overregulation and fear keep the global credit and capital markets closed. Trade and capital flows continue to decline for years as globalization goes into reverse, and the psychology of nations becomes much more defensive and nationalistic.

Leading through uncertainty
These descriptions are intentionally stylized to enliven them; many permutations are possible. Scenarios for any company and industry should of course be tailored to individual circumstances. What we hope to illustrate is the importance for strategists of considering previously unthinkable outcomes, such as the rollback of globalization. Unappealing as three of the four scenarios may be, any company that sets its strategy without taking all of them into account is flying blind.
So executives need a way of operating that’s suited to the most uncertain business environment since the 1930s. They need greater flexibility to create strategic and tactical options they can use defensively and offensively as conditions change. They need a sharper awareness of their own and their competitors’ positions. And they need to make their organizations more resilient.

Most companies acted immediately in the autumn of 2008 when credit markets locked up: they cut discretionary spending, slowed investment, managed cash flows aggressively, laid off employees, shored up financing sources, and built capital by cutting dividends, raising equity, and so forth. While prudent, these actions probably won’t produce the short-term earnings that analysts expect, at least for most companies. In fact, it’s time they abandoned the idea that they can reliably deliver predictable earnings. Quarterly performance is no longer the objective, which must now be to ensure the long-term survival and health of the enterprise.

More flexible
Companies must now take a more flexible approach to planning: each of them should develop several coherent, multipronged strategic-action plans, not just one. Every plan should embrace all of the functions, business units, and geographies of a company and show how it can make the most of a specific economic environment.
These plans can’t be academic exercises; executives must be ready to pursue any of them—quickly—as the future unfolds. In fact, the broad range of plausible outcomes in today’s business environment calls for a “just in time” approach to strategy setting, risk taking, and resource allocation by senior executives. A company’s 10 to 20 top managers, for example, might have weekly or even daily “all hands on deck” meetings to exchange information and make fast operational decisions.

Greater flexibility also means developing as many options as possible that can be exercised either when trigger events occur or the future becomes more certain. Often, options will be offensive moves. Which acquisitions could be attractive on what terms, for instance, and how much capital and management capacity would be required? What new products best fit different scenarios? If one or more major competitors should falter, how will the company react? In which markets can it gain share?

As companies prepare for such opportunities, they should also create options to maintain good health under difficult circumstances. If capital market breakdowns make global sourcing too risky, for example, companies that restructure their supply chains quickly will be in much better shape. If changes in the global economy could make a certain kind of business unit obsolete, it’s critical to finish all the preparatory work needed to sell it before every company with that kind of unit reaches the same conclusion.

A crisis tends to surface options—such as how to slash structural costs while minimizing damage to long-term competitiveness—that organizations ordinarily wouldn’t consider. Unless executives evaluate their options early on, they could later find themselves moving with too little information or preparation and therefore make faulty decisions, delay action, or forgo options altogether


Bob Cooper said...

I wanted to be sure that everyone saw the flow of comments from this posting:

This was a great piece by McKinsey. My partners and I , all involved in strategy work, along with many industry watchers, see that current approaches to strategy formulation are falling well short of what is needed in the current volatile, uncertain and competitive world. The deficiency in current approaches is being widely recognized in recent papers/articles published by luminaries in publications such as HBR and this one by McKinsey.

It is important that scenarios are developed specifically to each company and are part of a broader development of strategic options – using external option sets that are not part of a broader approach merley become interesting exercises in future casting.

Just as you cannot fight a global asymmetric terrorist war, with a cold war linear planning methodology, you cannot make complex decisions in a volatile and uncertain world with a predominantly traditional planning methodology. The methodology must match the environment

What companies need is a new approach that will enable them to operate in a way best suited to this most uncertain business environment. Companies need a platform where they can rapidly and effectively simulate the ecosystem in which they operate, where they can create and test strategic and tactical options. It should allow a company to test and simulate a broad set of macroeconomic outcomes and strategic responses against a set of potential scenarios and variables against that ecosystem. That way a company will get a significantly deeper insight into how robust are their strategies; how different players(competitors, customers, will respond to those strategies under different conditions and conversely how each player would respond to competitor strategies ( e.g. price cuts to grab market share). It will provide a company a sharper awareness of their own position and the positions of all consequential players (e.g. competitors, regulators, capital providers, etc) in their industry ecosystem.

Most companies in the current environment are cautious about trying new approaches and investing some discretionary money – however as McKinsey clearly states it’s time to look at fresh approaches to gain advantage from the many opportunities that emerge in such downturns.

Peter J Bryant

TransTech USA LLC

Although I am quite sure of the necessity of more strategic options these days, don't you think that a major portion of our management time should be now, more than always, be directed towards tactical wins in order to cripple competition? Some strategist are seeking partnerships during uncertainty, which I think over the long run will lead to lower strategic seperation.
Best regards

Sami Nashwan
Director Marketing-Segments


You raise a good point – I believe companies cannot afford to have a singular focus – they must be focused on the here and now – survival and advantage – and they must be focused on the long term – specifically what options should they be pursuing and investing in now that give them the best opportunities for the future – to do this effectively they must define certain futures and understand the implications for their industry and company within each of those scenarios’ – then they can develop options and value them in each of those scenarios – this provides optionality for the future. To then.
really test those options is to then run them inside a model that simulates the ecosystem in which that company exists which takes account of all players, their complex interdependencies and behaviors.

From that a company can determine under each scenario how competitors, regulators etc would/may respond to your strategies under given conditions (e.g. GDP growth, credit flows etc)


Peter J Bryant

TransTech USA LLC

Bob Cooper said...

More from Peter Bryant:

Some further musings

There is no doubt that companies today face a dilemma – tighten their belts, preserve their balance sheets and just survive or should they be investing across a portfolio of options that will spur growth either now and/or put them at the front of their competitors for when the recovery comes! Can they do both? If they invest for growth what should a company do –

Enter new regions?
Produce new products?
Change business models?
Acquire competitors or adjacent companies?
Crush competitors with pricing; service offerings etc
Etc etc

A company faces perplexing considerations in order to determine which of these options or combination of options best positions it for the future – these include

-What if the current crisis continues for 1, 2 or 3 years or even more
-What if the current lack of credit continues into 2010,2011 etc
-What if GDP growth remains flat for more than 12 months?
-How will customer behavior change?
-What of new competitors enter the market with new models, deep pockets, disruptive technology etc?
-If I do nothing what could happen?

It is these considerations, along with the potential responses to your strategies from competitors; customers; regulators; financial markets; media etc that massively increase the complexity and uncertainty of these decisions beyond the capability of existing methodologies and tools (e.g. SWOT, Porter’s forces, Mone Carlo analysis etc