20/20 Foresight: Crafting Strategy in An Uncertain World
By Hugh Courtney
Harvard Business Review Press, Boston, 2001
What better way to start 2020 than a book called 20/20 Foresight?
There’s an old Danish proverb that says,
“It is difficult to make predictions, especially about the future.”
Difficult for sure, but we do it all the time anyway. Whether it’s something as simple as arranging to meet friends after work, or as complex as developing business strategy, we’re making predictions and dealing with uncertainty.
20/20 Foresight: Crafting Strategy in An Uncertain World is about how to define business strategy in the face of uncertain predictions about the future.
Levels of Uncertainty
The first thing Courtney does, and probably the most valuable part of the book, is to show us that not all uncertainty is alike. He identifies four levels of uncertainty.
In situations with Level 1 uncertainty, there is only one possible outcome, or a very narrow range of outcomes. An example might be predicting population growth to estimate the size of a potential market. Population growth is well-understood and changes relatively slowly, so projecting, say, ten years into the future, does not involve much uncertainty.
With Level 2 uncertainty there is a small set of discrete, mutually exclusive outcomes. Take government regulation. The government could decide to step in and regulate political advertising on social media, for example. While the exact regulations may not be known, there is only a finite number of ways this can be done. Policy analysts should be able to identify the most likely types of regulation and maybe even assign probabilities to each one.
Under conditions of Level 3 uncertainty there is a continuous, rather than discrete, range of possible outcomes and the actual outcome could fall anywhere in the range. A good example would be trying to predict the value of the S&P 500 stock index five years from now.
Finally, Level 4 represents radical uncertainty. Here there is true ambiguity, many “unknown unknowns” and both the range and the nature of possible outcomes is unbounded.
As time passes and more information becomes available, the level of uncertainty decreases.
Knowing the type of uncertainty you’re dealing with helps you set strategy. Courtney lays out a set of questions that people should ask themselves when defining strategy, and provides some guidance on how to answer those questions depending on the prevailing level of uncertainty.
Shape or Adapt?
Should you try to shape the market or industry or situation you’re in, or adapt to it?
To be a shaper, you’ll need to introduce fundamentally new products, services or business processes. You might need to redefine industry standards. You could reshape your industry through mergers, acquisitions, integration or divestment. Or you might replicate existing business systems in new markets. As a shaper you will influence your competitiors’ behavior.
Adapters on the other hand may choose to follow a shaper’s lead. This could be a good hedge against multiple possible outcomes (level 2 or 3 uncertainty). It requires continuous experimentation and a flexible organization to adapt quickly and successfully.
Apple’s introduction of the iPhone is a clear example of a company, well Steve Jobs really, deciding to be a shaper. Apple completely redefined the mobile phone industry despite the presence of established incumbents.
Now or Later?
Do you need to act now, or can you wait, perhaps until more information become available?
Courtney suggests that “no regret” moves, that is moves that make sense no matter what the outcome, should be done now.
Beyond that, you need to ask yourself are you trying to maximize upside potential or minimize downside risk (i.e. reduce uncertainty)? You’ll need to make big bets for the former, and explore real, present-day options for the latter.
When looking at real options, Courtney suggests they should provide an asymmetrical payoff. In other words, a small investment should yield a large reward. The Black-Scholes model can help you figure this out. Examples include options that help you learn about new business opportunities, markets or technologies, and options that help you hedge agains undesirable outcomes.
Courtney says that situations of high uncertainty favor exploring real options, while known competitive threats favor making bit bets.
Focus or Diversify?
Should you focus your investments or diversify?
Courtney describes different types of investments that can help reduce risk:
- Diversification: a group of investments that have uncorrelated outcomes or risk.
- Hedge: investments that have negatively correlated outcomes.
- Insurance: provides specific payoffs for worst-case scenarios
If you’re a shaper acting now, Courtney says you should focus. If you’re an adapter who can afford to wait, you should diversify.
The answer also depends on the type of uncertainty you’re facing.
- Level 1: No need to diversify. In fact, diversification would be wasteful.
- Level 2: Use hedging and/or insurance to reduce risk
- Level 3: Diversification plus insurance to guard against the worst-case outcomes
- Level 4: Focus if you’re willing to accept high risk/reward, otherwise diversify and insure.
Courtney ends the book with some tools for thinking about strategy under radical Level 4 uncertainty. He suggests working backwards from your desired strategy and asking questions like:
- “What would you have to believe …” or “What assumptions would you have to make …” in order for a given strategy to succeed?
- Or what facts or developments are needed to reduce the uncertainty to Levels 3, 2 or 1?
All in all, 20/20 Foresight is a powerful way of thinking about and developing strategy in uncertain conditions.
A fresh look at strategy under uncertainty – a 2008 interview with Hugh Courtney in McKinsey Quarterly