Saturday, February 19, 2011

Strategic Comparators and Responders: Reinventing Strategy Formulation

The most relevant but most ignored fact of corporate strategy is that competitive strategy can rarely be drawn up in isolation. In any industry, the strategies pursued by individual firms impact not only the industry structure but also affect the competitive strategies of all other constituent firms of the industry. Yet, firms and strategy leaders find it expedient to draw up strategies as though only they exist in the industry individually. It is not uncommon, for example, to see almost all firms in an industry aspiring to achieve growth rates above the industry average, move up the industry pecking order by a few notches, achieve the largest market share or secure the highest profitability. No wonder therefore that only a few firms succeed in achieving their operational aspirations and most land up with randomly unsuccessful and patchily successful performance.

Given that corporate strategy in a firm is typically drawn up at the level of the chief executive officer, chief strategy officer, chief financial officer and other CXOs all with requisite capabilities, the ostrich like manner in which corporate strategy is drawn up defies logic. The reasons are often three pronged: structural, systemic and behavioral. Strategy is a highly complex intellectual activity which integrates established data as much as it factors in uncertain aspirations. The larger the organization the greater is the need for inclusivity, calling for ground level strategy development in all functions, domains and regions, with a sharp eye for internal and external factors. Yet, typically the strategy department is usually the smallest one in a firm, denying structurally the ability to capture all the required nuances and details, and conduct necessary sophisticated analyses.

Systemically, industrial managers and leaders, despite the strong managerial learning that emphasizes coping with uncertainty with a wide range of tools, get inclined to accept quantitative data rather than qualitative information or interpretations. Behaviorally, professionals involved in strategy development tend to believe that strategy formulation is an esoteric science which only strategy specialists can carry out. This factor and the distance strategists tend to create between themselves and other organizational members act as behavior barriers between ground level realities and capabilities of the broader organization and the senior level aspirations and potentialities. These factors, and lack of quality external data or the cost and time required to access such data, act as systemic deterrents to developing a comprehensive strategic canvas and achieving organizational inclusivity in strategy formulation.

Pitfalls of introverted strategy

Every strategist maintains that his or her strategic plan is developed based on opportunities and risks inherent in the economic environment and the likely moves of competitors. Apart from the fact that such claims are often no more than armchair predictions, the benefits of any strategic plan disappear the moment the first year of the strategic plan is converted into the monthly budget for the firm. This is because thereafter the firm keeps monitoring its performance against the budget rather than external developments or competitor achievements. As a result, the firm misses out the opportunity to overcome new challenges or spot new opportunities. As economic environment becomes more volatile and competitive dynamics become more intense by the day, there is every need for all professionals who treat strategy as an exclusive preserve to look at a more pervasive and expansive approach to strategy formulation.

A classic instance of the introverted strategy is found in certain recent developments in the top crust of the Indian information technology industry. One of the top IT players was preoccupied with implementing strategies developed at the beginning of economic downturn and was oblivious to the moves being made by other top players to build capacities as global economy began to come out of woods. As a result, the firm lost the edge in terms of consulting capacity and customer access, and got relegated to a lower spot. An inability to assess, or accept, the superiority of other more effective mobile operating systems and a belief in its own proprietary system made a leading global mobile maker such as Nokia lose the edge in smart phones. Several Indian pharmaceutical majors who have ignored the plans of late starters to aggressively establish capacities or create marketing organizations saw their market share drop precipitously.

Certainly, directional stability for business and performance comparison vis-a-vis plans are extremely important for firms to stay focused. Given that most strategic investments such as capacity creation have lead times of several years and even tactical operations such as inventory management involve lead times in months it is impractical to have continuously dynamic plans, even if they are responsive to external developments. That said, given the fundamental responsibility of strategy formulators of delivering sustainable growth for the firm, innovative ways must be found to balance internal stability and external volatility. Ease of making internally focused plans and difficulty of compiling reliable external information or lack of organization to support external intelligence should be the least of the reasons to stay only inward focused, and in the process oblivious of external developments. The wise firm must institutionalize a process of strategic comparison and responsiveness as a strategic management ethic.

Key external themes

The theory of strategic comparators and responders herein proposed is quite different from the existing concepts of competitive benchmarking or strategy development. Competitive benchmarking essentially focuses on metrics that are measurable and are reflective of operational and market performance. These could be market share, published financials and stock price. The paradigm of strategic comparators and responders includes external benchmarking but goes beyond that into a holistic reinvention of the art and science of strategy formulation. It is based on the premise that operational metrics or cross-sectional snapshots of a firm or its competitors do not necessarily capture the longitudinal impact or potential of external developments and potential external-internal (dis)equilibrium. Further to that, simple benchmarks fail to project the transformational trends that could potentially rewrite the comparative attractiveness of economies and competitive positioning of firms. Prediction of transformational phenomena requires superior analysis and judgment on the part of strategy formulators, and CSOs. For example, when the concept of Brazil-Russia-India-China (BRIC) economies as the rapid growth economies of the future was propounded a few years ago there were not many takers; it became, however, a reality sooner than forecast. Firms which embraced the BRIC concept early on benefitted from the rapid and transformational economic growth of such countries.

Strategic comparators emerge as both metrics and scenarios. Strategic responders are strategies that reset the firm’s strategy in response to the strategic comparators. The theory uses metrics as a means to predict future based on statistical sciences and experiential judgments, given the complexity. Essentially, comparators occur at four levels over the two dimensions of economy and industry: macro-economic, micro-economic, macro-industrial and micro-industrial. Taking the example of India, current macro-economic trends and social aspirations indicate the potential for a major transformation in terms of becoming the third largest economy in ten to fifteen years, with greater rural inclusivity. At a micro-economic level, changing demographics which would lead to around sixty percent of population being of thirty years of age or below portend a major transformation in consumption patterns. From a macro-industrial perspective, new industrial sectors catering to children and youth could be the new drivers of industrial growth. At micro-industrial level, firm and industry specific competencies honed in industries such as automobiles, pharmaceuticals, information technology, engineering, communication, defence and electronics could become factors of national comparative advantage. Any strategic planning process must, therefore, address the economic-industrial scenario.

The practice of strategic planning in the 1960s and 1970s advocated analysis of economic and technological environment as a primary component of the long range planning process. Firms felt that it was important to have economic analysts, including econometricians, in the long range planning departments. However, the slow rates of change in external environment of yesteryears caused such analytics appear as a redundant, non-value adding exercise over time. Not surprisingly, strategists and CEOs began to focus more on firm-specific internal factors than on external factors, a trend which got fortified over the 1980s to 2000s. CK Prahalad’s concept of core competencies of the firm reinforced the trend. Although Michael Porter focused on micro-industrial environment as an influence over competitive strategy, his prescription also focused on firm level competencies. With the tumultuous changes in global economic environment, emergence of rapidly developing economies such as China and India and exponential growth in new technologies, an understanding and forecasting of external economic and technological drivers, together with a more nimble and perceptive strategic response mechanism, assumes great importance for strategists.

Connecting the dots faster

In the emerging world, uncertainty is the only certainty and volatility is the only steady factor! The emerging environment does not lend itself to classic statistical and technical analyses of the past to arrive at the future. The scale and flow of business has enhanced globally to such an extent that for the first time in the 2000s, the fallibility of large individual firms could put to risk whole economies. Strategy formulators are now expected to marshal intuition, experience and analytics in equal measure to develop judgments on future. The CXOs who seek comfort of pure analytics, therefore, are unlikely to take their firms far; neither would be the CXOs who are solely intuitive or biased by their own experiences. Emerging economies could throw up new points of inflexion unexpectedly. As an example, even in the matter of air transportation where sectors are subject to rigid governmental controls, and hence apparently predictable, the trio of Emirates, Etihad and Qatar airlines have grown so much over the last five years that they can today, in the aggregate, claim more air passenger kilometers than the largest established carriers such as Lufthansa or British Airways can claim. If the CEOs of the established airlines tried to forecast future scenarios through yearly measurement of air kilometers they would have been off the mark as well as late to respond.

Strategy formulators in the new era need to not only understand the dots that could lead them to the future but also learn to connect them faster. Not many overseas firms perhaps predicted that China would make massive investments for super fast bullet trains and therefore let the initiative slip away into indigenous development of such trains by China (good for China of course). Not many advanced nations and their national firms predicted that India would double its growth rate to 8 plus per annum and consequently missed the opportunity to participate in the growth and even accelerate it. Japan, and Japanese firms, for example, had been so close to, yet so far from, India; they could not foresee that India could be one of the largest markets and production centers for automobiles, electronic and consumer goods. Even today, despite this experience, many countries and national firms are still unwilling to visualize that India is at the cusp of a new qualitative revolution, taking the growth to a new trajectory. Similarly, Indian government and the firms as well as financial institutions do not seem to realize that India can acquire overseas assets much more expansively and decisively than it has done so far.

From the behavior of nations, societies, governments and economies to the aspirations of firms and professionals, the external world presents innumerable indicators of a transformational future; and there could be diverse futures relevant for different firms. CXOs must have the perspicacity and capability to see the futures beyond the obvious through multiple lenses. Before mild ripples of change turn into huge waves of transformation, firms would have only small windows of time to retool their strategies and redirect their execution. Unidirectional companies obviously face greater challenges on this front, the saving grace being that growth economies do offer base line growth in all sectors while offering hyper growth in select sectors. Conglomerates have greater flexibility to capture opportunities across the economy. However, whether specialized or diversified, companies need to reintroduce economic, demographic, technological and social forecasting to meet future challenges and opportunities as well as appropriate mechanisms to respond to them. This external orientation requires a major transformation in how budgets and strategic plans are formulated in firms.

Strategic simulations and strategic budgets

Firms would need to reconfigure the strategic planning and budgeting processes by a two-way equilibration. On one hand, the strategic plans should be unburdened of the needless quantitative load while on the other certain foundational strategic elements should be introduced in the budgeting processes. To enable this, strategic plans while being retained on a five year rolling basis must be developed in terms of multiple scenarios rather than with singular quantitative precision. Simultaneously, the annual budgeting cycle would need to be extended into a rolling two year span to provide the potential to cover strategic programs from investment to commercialization cycle. This twin change would enable companies to be prepared for dynamic changes in environment. A two year strategic budgeting cycle, though unusual in the current corporate practice for the extended span, would be the right transformation for operating executives to view their programs with the right strategic perspective. A five year scenario-driven strategic plan, though also could be unusual for absence of quantitative rigor, would enable strategic readability and flexibility for firms.

The strategic budgeting process would provide ample potential to understand fledgling strategic directions of the incumbent firms in an industry. The company annual reports, especially in India, provide a wealth of information on physical and financial parameters and investment indices, apart from standard information relating to balance sheet, income statement, cash flow statement and asset schedule. Some of these include information on underlying strategic parameters such as licensed capacities, installed capacities, production, sales, imports, exports, consumption of materials, inventories, energy consumption, technology imports, R&D investments, indigenization efforts, senior managerial remuneration etc. Most information is also made available on segmental or product basis. The information pool enables strategists to quantify and judge trends relating to a number of strategic parameters such as product specialization, export orientation, import dependence, asset intensity, research commitment, energy efficiency, import substitution, financial prudence, operational excellence and so on. Strategic budgets, by integrating such quantitative strategic parameters in bi-annual planning processes, equip the larger organization to deliver operations in line with the corporation’s strategic intent.

The strategic simulations would, on the other hand, develop multiple scenarios of likely external environment, competitor moves and potential strategic fit between the firm and any of the scenarios. As discussed earlier the economic and industrial environments can be simulated in a 2X2 matrix of macro and micro levels. Each environmental facet can be, in turn, assessed on a 3X3 matrix of interplay of optimistic, likely and pessimistic economic opportunity scenarios on one hand and dominating, co-existing and declining competitor dynamics on the other, a firm would have thirty six scenarios in which it can play its act. Assuming again that the firm chooses to play by an aggressive, middle of the road or conservative competitive strategy there would be a total of one hundred eight scenarios that could develop for the firm. The ability of the firm to deep-dive into each of the primal scenarios of opportunity, competition and competitive strategy in terms of various causative triggers could lead to even more intense scenario build-up. Economic opportunity even in one scenario, say optimistic, could be characterized by different levels of national savings, inflation and foreign direct investment; or by different rates of growth in agricultural, industrial and service sectors, for example. Competitor actions, say could be characterized by different levels of cash generation, cash deployment and external financing; or different levels of emphasis in core domains of research, manufacturing and marketing. A firm in each of its competitive strategies could seek out a cost position, differentiated position or niche position. The possibilities are endless; therefore the new age firm would need a new way of organizing the strategic planning function in a more intellectually reinforced way.

A new paradigm of strategic planning

To be able to meet the new age challenges of internally competent and externally sensitive strategic planning, strategic planning departments need to be expanded and restructured into three clear specializations. The first specialization stream would be driven by economists and technologists best equipped to forecast economic and technological scenarios. The second specialization stream would focus relentlessly on competitive intelligence to identify strategies and execution plans of competitors. The third specialization would be internally driven, analyzing the firm’s strengths and weaknesses, and developing the firm’s strategic options to achieve a fit with the multiple economic and technological scenarios. The chief strategy officer would not only be an erudite synthesizer of the enormous amount of information thus generated but also be an outstanding collaborator of multiple specialists to arrive at the most plausible set of strategic comparators and the most feasible set of competitive strategies. The holistic strategic planning process identifies drivers of competitive strategy, in an eclectic combination of various theories of strategy gurus, from Drucker, Ansoff and Ohmae to Prahalad, Porter and Kaplan, just to quote a few. The new age chief strategy officer must accordingly be a professional par excellence who can pioneer and institutionalize the new paradigm of strategic comparators and responders in the firm.

Posted by Dr CB Rao on February 19, 2011


Narayanan said...

It is indeed regrettable that Strategy groups tend to be either isolated or relegated to a marginal function, especially in firms with CXOs who value tactics and short term performance over longer term vision/goal i.e., survival as the main motivator, not 'thrival'. In addition to the three specialist groups identified in the blog, I would also suggest an additional group with focus on "truth seeking" i.e., evaluate how the specific strategy/predicted scenarios play out to enable appropriate adjustments in real-time to ensure relevance and alignment with overall vision and mission of the organization. This group should also be accountable for capturing "what works, what does not work" type of information and additionally serve as an "internal auditor" to continually assess the robustness of decision making processes used in the organization. Senior managers tend to make decisions based on heuristics but invariably succumb to hubris be it at the SBU or at the whole organizational level. Techniques such as "premortem" advocated by Gary Klein and acknowledging the upside (and downside) of Irrationality in the Workplace as articulated by Dan Ariely will help managers minimize or eliminate biases (e.g., overconfidence, confirmation, risk aversion etc) in decision making. As noted in the blog, a savvy Strategic Management group will have the capability to integrate both qualitative and quantitative data to identify opportunities (business, people and process) for the organization and thus embody the collective conscience of the senior leadership team. Such a group will be an asset to the organization and members of this group should be passionate and driven to co-create a "transcendental" firm in partnership with the senior leadership of the organization to ensure sustained value creation for all stakeholders.

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