Strategic Planning Process and Key Components:

Strategic planning requires three components:

Four levels of uncertainty

Available strategically relevant information tends to fall into two categories. First, it is often possible to identify clear trends, such as market demographics, that can help define potential demand for a company’s future products or services. Second, if the right analyses are performed, many factors that are currently unknown to a company’s management are in fact knowable.

The uncertainty that remains after the best possible analysis has been undertaken is what is called residual uncertainty - for example, the outcome of an ongoing regulatory debate. But quite a bit can often be known despite this. In practice, residual uncertainty facing most strategic - decision makers falls into one of four broad levels.

Level I: A clear enough future

The residual uncertainty is irrelevant to making strategic decisions at level I, so managers can develop a single forecast that is a sufficiently precise basis for their strategies.

Level II: Alternative futures

The future can be described as one of a few discrete scenarios at level II. Analysis can’t identify which outcome will actually come to pass, though it may help establish probabilities. Most important, some, if not all, elements of the strategy would change if the outcome were predictable.

Many businesses facing major regulatory or legislative change confront level II uncertainty. Consider US long-distance telephone providers in late 1995, as they began developing strategies for entering local telephone markets. Legislation that would fundamentally deregulate the industry was pending in Congress, and the broad form that new regulations would take was fairly clear to most industry observers. But whether the legislation was going to pass and how quickly it would be implemented if it did were still uncertain. No amount of analysis would allow the long-distance carriers to predict those outcomes, and the correct course of action - for example, the timing of investments in network infrastructure - depended on which one materialized.

In classic level II situations, the possible outcomes are discrete and clear but hard to predict

In another common level II situation, the value of a strategy depends mainly on competitors’ strategies, which cannot yet be observed or predicted. For example, in oligopoly markets, such as those for pulp and paper, chemicals, and basic raw materials, the primary uncertainty is often competitors’ plans for expanding capacity. Economies of scale often dictate that any plant built would be quite large and would be likely to have a significant impact on industry prices and profitability. Therefore, any one company’s decision to build a plant is often contingent on competitors’ decisions. This is a classic level II situation: the possible outcomes are discrete and clear, and it is difficult to predict which will occur. The best strategy depends on which one does.

Here, managers must develop a set of discrete scenarios based on their understanding of how the key residual uncertainty might play out. Getting information that helps establish the relative probabilities of the alternative outcomes should be a high priority. After establishing an appropriate valuation model for, and determining the probability of each possible outcome, the risks and returns of alternative strategies can be evaluated with a classic decision analysis framework. Particular attention should be paid to the likely paths the industry might take to reach the alternative futures, so that the company can determine which possible trigger points to monitor closely.

Level III: A range of futures

A range of potential futures can be identified at level III. A limited number of key variables define that range, but the actual outcome may lie anywhere within it. There are no natural discrete scenarios. As in level II, some, and possibly all, elements of the strategy would change if the outcome were predictable.

Companies in emerging industries or entering new geographic markets often face level III uncertainty. Consider a European consumer goods company deciding whether to introduce its products to the Indian market. The best possible market research might identify only a broad range of potential customer penetration rates, say, from 10 percent to 30 percent, and there would be no obvious scenarios within that range, making it very difficult to determine the level of latent demand.

The analysis in level III is similar to that in level II: a set of scenarios describing alternative future outcomes must be identified, and analysis should focus on the trigger events indicating that the market is moving toward one or another scenario. Since there are no other natural discrete scenarios in level III, deciding which possible outcomes should be fully developed into alternative scenarios is a real art. But there are a few general rules. First, develop only a limited number of alternative scenarios - the complexity of juggling more than four or five tends to hinder decision making. Second, avoid developing redundant scenarios that have no unique implications for strategic decision making. Third, develop a set of scenarios that collectively account for the probable range of future outcomes and not necessarily the entire possible range. Establishing the range of scenarios should allow managers to decide how robust their strategies are, to identify likely winners and losers, and to determine, at least roughly, the risk of following status quo strategies.

Level IV: True ambiguity

A number of dimensions of uncertainty interact to create an environment that is virtually impossible to predict at level IV. In contrast to level III situations, it is impossible to identify a range of potential outcomes, let alone scenarios within a range. It might not even be possible to identify, much less predict, all the relevant variables that will define the future.

Level IV situations are quite rare, and they tend to migrate toward one of the others over time.

Situation analysis at level IV is highly qualitative. Still, it is critical to avoid the urge to throw up your hands and act purely on instinct. Instead, managers need to catalog systematically what they know and what it is possible to know. Even if it is impossible to develop a meaningful set of probable, or even possible, outcomes, managers can gain a valuable strategic perspective. Usually, they can identify at least a subset of the variables determining how the market will evolve over time. They can also identify favorable and unfavorable indicators of these variables - indicators that will let them track the market’s evolution over time and adapt their strategy as new information becomes available.

Strategic Posture and Moves in Level I’s “clear enough future”

In predictable business environments, most companies are adapters. Analysis is designed to predict an industry’s future landscape, and strategy involves making positioning choices about where and how to compete. When the underlying analysis is sound, such strategies by definition consist of a series of no-regrets moves.

Adapter strategies in level I situations are not necessarily incremental or boring. For example, Southwest Airlines’ no-frills, point-to-point service is a highly innovative, value-creating adapter strategy, as was Gateway 2000’s low-cost assembly and direct-mail distribution strategy when it entered the personal-computer market in the late 1980s. In both cases, managers identified opportunities, in low-uncertainty environments, that could be developed within the existing market structure. The best level I adapters create value through innovations in their products or services or through improvements in their business systems, without fundamentally changing the industry.

It is also possible to be a shaper in level I situations, but that is risky and rare, since level I shapers, hoping fundamentally to alter long-standing industry structures and conduct, increase the amount of residual uncertainty - for themselves and their competitors - in otherwise predictable markets. Consider the overnight delivery strategy of Federal Express. When the company entered the mail-and-package delivery industry, a stable level I business, FedEx’s strategy in effect created level III uncertainty for itself. In other words, even though the chief executive officer, Frederick W. Smith, commissioned detailed consulting reports that confirmed the feasibility of his business concept, only a broad range of potential demand for overnight services could be identified at the time. For the industry incumbents, such as United Parcel Service, FedEx created level II uncertainty. FedEx’s move raised two questions for UPS: Will the overnight delivery strategy succeed? And will UPS have to offer a similar service to remain a viable competitor in the market?

Over time, the industry returned to level I stability but with a fundamentally new structure. FedEx’s bet paid off, forcing the rest of the industry to adapt to the new demand for overnight services.

Strategy Posture and Moves in Level II’s “alternative futures”

If shapers in level I try to raise uncertainty, in levels II through IV they try to lower it and create order out of chaos. In level II, a shaping strategy is designed to increase the probability that a favored industry scenario will unfold. A shaper in a capital-intensive industry, such as pulp and paper, for example, wants to prevent competitors from creating excess capacity that would destroy the industry’s profitability. Consequently, shapers in such cases might commit their companies to preempting competition by building new capacity far in advance of an upturn in demand, or they might consolidate the industry through mergers and acquisitions. But even the best shapers must be prepared to adapt. Consider the Microsoft Network (MSN). It began as a shaping strategy, but in the battle between proprietary and open networks, certain trigger variables - growth in the number of Internet and MSN subscribers, for example, and the activity profiles of early MSN subscribers - provided valuable insight into how the market was evolving. When it became clear that open networks would prevail, Microsoft refocused the MSN concept on the Internet. Microsoft’s shift shows that choices of strategic posture are not carved in stone and underscores the value of maintaining strategic flexibility under uncertainty.

The best companies supplement their shaping bets with options that allow them to change course quickly if necessary. Because trigger variables are often fairly simple to monitor in level II, it can be easy to adapt or reserve the right to play.

Strategy Posture and Moves in Level III’s “range of futures”

Shaping takes a different form in level III. If at level II shapers are trying to promote a discrete outcome, at level III they are simply trying to move the market in a general direction because they can identify only a range of possible outcomes. Consider the battle over standards for electronic-cash transactions. Mondex International, a consortium of financial-services providers and technology companies, was attempting to shape the future by establishing what it hoped would become universal e-cash standards. Its shaping posture was backed by big-bet investments in product development, infrastructure, and pilot experiments to speed customer acceptance. In contrast, regional banks, which didn’t yet have the deep pockets and skills necessary to set standards for the e-payment market but wanted to be able to offer their customers the latest electronic services, were mainly choosing adapter strategies. An adapter posture at uncertainty levels III or IV is often achieved primarily through investments in organizational capabilities designed to keep options open.

Reserving the right to play is a common posture in level III. Consider a telecommunications company trying to decide whether to make a $1 billion investment in broadband cable networks in the early 1990s. The decision hinged on level III uncertainty, such as the demand for interactive TV service. No amount of solid market research could precisely forecast consumer demand for services that didn’t even exist yet. However, incremental investments in broadband network trials could provide useful information and would put the company in a privileged position to expand the business in the future should that prove attractive.

Strategy Posture and Moves in Level IV’s “true ambiguity”

Paradoxically, though level IV situations involve the greatest uncertainty, they may offer higher returns and lower risks for companies seeking to shape the market than situations in levels II or III. Recall that level IV situations are transitional by nature, often emerging after major technological, macroeconomic, or legislative shocks. Since no player necessarily knows the best strategy in these environments, the shaper’s role is to provide a vision of an industry structure and standards that will coordinate the strategies of other players and drive the market toward a more stable and favorable outcome.

Shapers may not need to make enormous bets to be successful in level III or IV situations. All that is required is the credibility to coordinate the strategies of different players in line with the preferred outcome. Netscape Communications, for example, didn’t rely on deep pockets to shape Internet browser standards; instead, it leveraged the credibility of its leadership team in the industry so that other players thought, "If these guys think this is the way to go, it must be right for us."

Reserving the right to play is common but potentially dangerous in level IV situations. A few general rules apply. First, look for a high degree of leverage. Say, for example, that an oil company is thinking of reserving the right to compete in China by buying an option to establish a beachhead and has a choice of maintaining a small but expensive local operation or developing a limited joint venture with a local distributor. All else being equal, the oil company should go for the low-cost option. Second, don’t get locked into one position through neglect. Options should be rigorously reevaluated whenever important uncertainty is clarified and at least every six months. Remember, level IV situations are transitional, and most will quickly move toward levels III and IV. The difficulty of managing options in level IV situations often drives players toward adapter postures. As in level III, such a posture in level IV is frequently implemented by making investments in organizational capabilities.