Risk asymmetry and robustness
We have already talked about risk: strategy is about the future, and the future is inherently unknowable with 100% certainty. So strategy is inherently risky, and a sensible strategy process is geared towards managing and minimising risks, primarily by increasing the quality of the information being taken into account when making decisions.
We tend to think of risk in simple terms – heads or tails, we win or we lose. But as Nassim Nicholas Taleb has argued throughout his work, risk is not usually as simple as this – it is often asymmetric in terms of probability and impact (and often both at once). We are all familiar with the risk asymmetry of the lottery ticket – the probability of winning is extremely low but we balance it with the asymmetry of the huge positive impact of winning.
When we buy a lottery ticket we know that our numbersmight come up, but we don’t go out immediately and buy an expensive sports car. Yet we habitually construct business plans on a single set of assumptions – and usually the most optimistic ones. We make our best guess about what customers might buy and the costs of delivering it to them, but we rarely consider what would happen if our guesses are out by 1%, by 25%, or by 100%. If we do raise the subject, we risk being criticised for not being committed to the strategy.
Business risk is rarely as linear and well-defined as the risks attaching to the lottery – which can be calculated to a high degree of precision. Because the risks are difficult to assess, it’s tempting to duck the issue. The problem is exacerbated when, as often happens in business, asymmetry works against us: the real probability of failure is high and the impact of failure is high (often the complete failure of the business).
An insurance company had been established for over 100 years but needed to implement a new strategy. It saw the future in distribution, and purchased a financial advice firm which had not been able to sell itself to other firms. The numbers presented to the board demonstrated that it could be successful – but internally, the insurance company’s management recognised that these numbers were equivalent to throwing a long string of double-sixes at dice. In practice the financial advice firm failed and the subsequent regulatory costs were material in forcing the insurance company to seek to being taken over itself. The risks inherent in the purchase had been hugely asymmetric.
Another insurance company was approached by a different, and hugely successful, financial advice firm who invited them to do business together. All the business projections based on extrapolation of current performance data looked good. But the insurance company’s Finance Director injected another assumption which he considered highly likely given the character of the other firm’s powerful but erratic CEO: that at some time or other the financial advice firm would collapse. In all scenarios when this occurred – whether in one week or in 15 years’ time – the deal was no longer viable. The insurance company terminated the discussion. The financial advice firm imploded some years later.
In simple terms a fragile strategy is one that needs lots of things to go right to succeed. A robust strategy has a good chance of success even if lots of things were to go wrong. There is no formula for assessing whether a strategy is fragile or robust: it is down to common sense. Investing in lots of low-cost projects, each of which has a high positive return if it succeeds (and the others fail), is an example of robust strategic thinking. Investing in one big project that requires double-sixes to succeed is fragile.
We have criticised the part played by strategy consultants, largely because their techniques tend to reinforce the “where we are now plus a bit” approach to strategy. Put another way, they tend to accept and reinforce the existing beliefs in a firm, including those that actively prevent the firm from conducting a sensible approach to strategy.
But there is a positive role for consultants, based on them being outside the client’s system: they can identify the beliefs that are operating and challenge the ones that are inhibiting progress. The role of the consultant in this scenario is to introduce tools and techniques that assist the client to determine the right strategy for themselves. This is a good example of second-order change: helping to improve the whole client system rather than dealing solely with localised problems.
Do we need a new strategy anyway?
The easy way to answer this is to look at business results. If they are poor, there is no other way to say it: the current strategy is flawed. Look for one or more of these tell-tale signs:
- we tend to copy what our competitors are doing;
- we rely on accepted cultural wisdom about how our business has always worked;
- when we do come up with a new strategy, it is normally a big idea that either needs double-sixes to succeed, or is beyond our capability to deliver (or both);
- the strategy seems to be in the right area, but is so ill-defined that the organisation has no chance to pull together to deliver it.
Developing a new and sensible strategy is a difficult and stretching exercise. But when it is done properly a successful initiative is likely to have the following characteristics:
- it has a deep connection with genuine customer wants which have not previously been met;
- it redefines the scope of existing markets rather than accepting current market boundaries;
- it actively identifies and eliminates costs that don’t match what the customer wants;
- it deals explicitly with how the organisation will deliver it.