Michael Raynor

Strategic Flexibility
By Michael Raynor A Deloitte Research Monograph Strategic Flexibility: Introduction The future's not ours to see. But why let that stand in the way of exploiting it? Companies that want to stake out a defensible market position in this uncertain and volatile marketplace are finding themselves at a loss. They must stay nimble in this environment; however, that often means sacrificing exactly what allows companies to compete for market dominance the scale and complexity of their organizations. Deloitte Research has developed Strategic Flexibility an approach that allows organizations to prepare effectively for a future they cannot predict. The framework of Strategic Flexibility requires that companies: Anticipate multiple scenarios; Formulate strategies for each; Acquire the capabilities to execute those strategies; Execute the "most likely" strategy; Be prepared to rapidly adopt one of the alternatives if market forces dictate. The next few pages take you through the concept of Strategic Flexibility in more detail, from recognizing the need for a new approach to dealing with uncertainty to successfully implementing this powerful framework: Strategic Flexibility: The Paradox How to prepare, when strategy itself is a paradox? Companies need a strategy, they have to plan, prepare and invest for the future. But who can predict the future accurately? How can a company anticipate which possible future scenario to count on? This is the paradox Strategic Flexibility seeks to overcome. Here we discuss the predicament companies find themselves in and start to understand how Strategic Flexibility can offer a solution.

Michael Raynor

The Paradox How will the market evolve? How will the competition behave? What is our strategy? There's nothing like a multi-billion dollar question to start a conversation. But this is exactly the issue that monopolized much of senior managements attention at a major telecom company for over two years. Thanks to a strategy engagement with Deloitte they found the answer. Deloitte helped this company decide how to navigate broadband's unpredictable future no small feat in an arena where each turn of the rudder, each strategic adjustment, could cost millions, if not billions, to execute. How did we do it? By replacing strategic commitment a lopsided bet on a single, stubborn vision of tomorrow with strategic flexibility: a framework nearly four years in the making, developed at Harvard and client tested, that helps companies prepare for futures they cannot predict. Companies need strategy. Who can deny that? They have to think about their future and how they will compete. And competing effectively requires investment commitment to capabilities, assets, people and customers. The problem is that effective commitment requires accurate prediction assumptions of how the future will unfold: what your customers will want, what the government will require, what your competitors will do, and how your own people will perform. Heres the rub: accurate prediction is impossible. Doris Day said it this way: the futures not ours to see. The S.E.C says it this way: past performance is no indication of future results. And Winston Churchill said it like this: The future is just one damned thing after another. Its an open secret that, to paraphrase W.C. Fields, we can predict anything but the future. The litany of good companies hurt by bad predictions is evidence enough that effective commitment is impossible. Which means strategy is impossible. Damn the strategy! Well compensate with agility! (Not so fast) If commitment wont work, maybe flexibility will, right? Sounds fair enough: rather than commit to investments based on predictions I know will turn out wrong, Ill just stay agile, bobbing and weaving, shucking and jiving as needed to adapt to my environment as it unfolds around me. Fine if youre a start-up with eight people and no assets. But the kind of large, complex organizations needed to achieve ambitious goals cant move as fast as the environment they compete in. Thats not a pathology of bigness, its a defining characteristic of it. In other words, big firms cant be small firms. And even if they could, its not always possible to respond in real time. By the time the need for action is clear, the ability to act might be gone. And even when organizations can respond, they run the risk of ceding first-mover advantage to competitors. In short, conventional notions of flexibility which are perhaps better captured by the

Michael Raynor

idea of agility are either impossible to implement or abandon the competitive high ground. Strategic Flexibility busts the paradox. Now you can take the fork in the road. Since effective commitment is impossible, and agility alone cannot address all possibilities, companies need the means to engage several paths simultaneously without diluting the resources ultimately necessary to strike boldly in a given direction. This is Yogi Berra's famous paradox - "When you come to a fork in the road, take it." Now companies can do just that - with Strategic Flexibility. Strategic Flexibility: The Framework
The four phases of Strategic Flexibility

There are four stages to Strategic Flexibility anticipate, formulate, accumulate and operate. Here we look at each element in more detail and learn what each entails for companies adopting the Strategic Flexibility approach. Anticipate: Identify the drivers of change and define the range of possible futures. Abandon the tendency to predict and adopt the capacity to anticipate. How? By developing a set of scenarios that bound future possibilities along lines of particular interest, thereby defining a range of relevant possible futures. Think of these scenarios as buoys in uncertain and potentially turbulent waters, each constituting a boundary marker that collectively serve to illuminate the future, rather than predict it. Carving out this possibility space will allow a company to think creatively and expansively about what might happen, and to define a finite set of possible futures within which it might have to operate. As it is typically practiced, scenario-based planning is very useful. It provides a context for interpreting events: you observe the world around you, sense the need to react, and respond based on the signals. It rehearses a company for the future and is a great start. But it's frequently not enough. Formulate: Develop an optimal strategy for each possible future and define "core" and "contingent" elements of these strategies.

Michael Raynor

Step two involves creating an optimal strategy for responding to each scenario, using the conventional tools of strategy formulation. In itself, all this accomplishes is to multiply the work of the strategist: instead of developing one strategy, he or she must now develop several. However, the power of this approach emerges in an analysis of the commonalities and differences between these optimal strategies. Specifically, those initiatives that apply to all possible scenarios can be considered core elements no-matter-what bets that can be pursued confident in the knowledge that they will form part of an optimal response to whichever future emerges. In contrast, initiatives specific to a particular optimal strategy are called contingent elements. Where core-element initiatives are no-matter-what bets, each contingent element is an onlyif bet an initiative to be pursued only if the scenario it targets begins to emerge. Accumulate: Acquire the elements required to execute the core strategy and take options on elements required for contingent strategies. With core and contingent elements in place, you'll determine two forms of investment: assets to be acquired to execute the core elements, and real options on assets needed to pursue contingent elements. Since core elements pay in the face of any future, acquiring the means to execute them bears little or no risk. A company requires these assets or capabilities, no matter what. Examples of core capabilities include CRM capabilities or the adoption of shareholder-focused performance metrics. We speak of real options to underscore that they are options indeed comparable to their financial counterparts. Consider the financial option. Its value driven by the price of the stock on which it is written, it gives the investor the right, but not the obligation, to buy the underlying asset (the stock) for specified price within a certain time period. The investor may exercise or abandon the option after observing the future price of a stock. As such, the option provides high-leverage exposure to the upside of a stock. Now consider the real option within the framework of Strategic Flexibility: Its value driven by market conditions and competitive dynamics, a real option is designed to give a company the right, but not the obligation, to increase investment in a contingent element supportive of a particular scenario. Asset light, it is a limited investment that creates high-leverage exposure to the upside of a market. But where financial options hedge financial risk, real options hedge strategic risk. How? Think of it this way: at a time when many companies eschew promising new technologies as too expensive or unproven technologies that might one day support or even save them a portfolio of real options constitutes strategy insurance; protecting, at an acceptable cost, your client's ability to capture worthwhile opportunities or to avoid disastrous consequences. In preparing for a future of multiple possibilities, real options serve as well-considered investments that hedge against sudden market or competitive shifts. They lock up assets that are potentially useful through, for example, partial equity stakes that have migration paths to full ownership, or binding alliances, or joint ventures with provisions for taking
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Michael Raynor

out your partner. Each of these control mechanisms can be constructed in a way that allows a firm to move in a measured fashion calibrated to the strategic value of a given asset, and thus conserve capital. As uncertainties in the market are resolved, the strategically flexible company exercises some options and abandons others, depending upon what it will need to exploit a future it can now see more clearly. Operate: Execute the core strategy, monitor the environment and exercise or abandon options as appropriate. With the core elements in place, and real options established to address all reasonable scenarios, the time has come to orchestrate your multi-track mix. Execute the core elements. Allocate the capital necessary to leverage the core element that is integral to the company's success, irrespective of what the future holds. Monitor the environment: competitive dynamics, government regulation, customer behavior, employee performance all the variables that affect the business. What are you looking for? Signs of uncertainties resolved. That will be your moment to strike. Let time resolve uncertainties and at the moment of resolution, exercise and abandon options as appropriate.