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How to Plan During Uncertain Times
An Interview with Hugh Courtney

Ubiquity, Volume 2001 Issue October, October 1 - October 31, 2001 | BY John Gehl 

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How to Plan During Uncertain Times


Risk cannot be switched "on" and "off." There will always be risk in business and in life. Hugh Courtney, author of the new book 20/20 Foresight: Crafting Strategy in an Uncertain World (Harvard Business School Press), describes the four levels of risk and suggests a systematic, analytical approach to decision-making in uncertain times. Courtney is an Associate Principal with the Global Strategy Practice at McKinsey & Company in Washington, D.C.


UBIQUITY: A short few weeks ago, and well after you wrote your book, America and the world experienced the terrible terrorist events of September 11th. Since your book is focused on an "uncertain world," we should probably ask you right away to offer a comment on the consequences of those effects on business, technology, and life as we know it -- or knew it.

HUGH COURTNEY: There is no doubt that the horrific events of September 11 will have consequences for business, technology and life as we know it that none of us can completely foresee at this time. This makes it an extremely challenging time for anyone attempting to make an informed strategic commitment -- say a major investment decision for a company, or a housing purchase for a consumer. But I think we can compound this challenge if we don't take the time to truly understand what has, and hasn't, changed in the aftermath of September 11. It is important to keep in mind that our world did not suddenly change from being "certain" to "uncertain" on September 11. Yet there is a real danger that we will fall into this trap. In 20/20 Foresight, I argue that decision makers (in business and everyday life) often take a binary view of uncertainty, where we think of uncertainty as either "on" or "off." This leads to systematic biases when making strategic decisions under uncertainty. For example, it would have been a mistake prior to September 11 to assume that business decision makers faced a "certain" world, one in which all existing trends could be easily extrapolated to develop reasonably precise forecasts of future value drivers. Likewise, it is a mistake to now assume that the future course of key business value drivers is completely ambiguous. The truth, of course, both pre- and post-September 11, lies somewhere in between.

UBIQUITY: What happens when uncertainty is "switched on"?

COURTNEY: The problem with this binary view of uncertainty is that decision makers, by systematically either under- or overestimating the level of uncertainty they face, will miss out on the threats and opportunities that an uncertain business environment provides. I am particularly worried that business decision makers in the next few months will treat the market environment as "uncertain," and will thus avoid undertaking a systematic analysis of what has truly changed for them and what remains relatively stable. As a result, I think we will see too many companies either avoiding making any strategic commitments, or at the other extreme, making uninformed big bets based on business intuition that may no longer be valid in today's environment. In either case, the outcome is likely to be poor.

UBIQUITY: In the face of unpredictability, what advice do you give to decision makers?

COURTNEY: First and foremost, to avoid this dangerous binary view of uncertainty. Examine the key value drivers of your business, and determine what has and hasn't changed since September 11. Undoubtedly, most decision makers will find that there are some variables that are truly ambiguous at this point. For example, I believe that decision makers today face various political, social, and macroeconomic uncertainties with near-term outcome ranges that cannot be bounded through any sort of systematic analysis. I am sure that there are experts out there that purport to understand exactly how the geopolitical situation will play out in the next 12 to 24 months, but I think such foresight just isn't possible yet. On the other hand, most business decision makers will also find that many other drivers of their strategy decisions haven't changed much. At the very least, analysis will enable these decision makers to bound the range of potential outcomes for these uncertainties. These decision makers can thus avoid "flying blind" on at least some of the most important drivers of their business decisions. Adopting this mindset toward uncertainty is essential to managing your business and managing your life. If we want to move forward in the wake of September 11's tragic events, we need to think hard about what has changed and what hasn't, thus avoiding the binary view of uncertainty, in which the world used to be predictable and now no longer is.

UBIQUITY: Let's explore that a little bit. What are some examples of things that have not changed?

COURTNEY: First, I should note that there is no one-size-fits-all answer here. The uncertainties that matter for any given strategy choice are obviously industry- and issue-specific. The uncertainties that the airline industry face post-September 11 are obviously quite a bit different from the uncertainties facing the telecommunications industry. Likewise, U.S. airlines face a different set of uncertainties when formulating their domestic versus their international route strategies today. Yet in working with my clients over the last few weeks, some common themes around "what has not changed" -- at least not much -- have emerged, including the fundamental sources of competitive advantage (such as cost positions, product quality, business relationships and so on), technology performance traits, and the regulatory environment (at least for most companies -- this wouldn't be true, for example, for airlines). And even when some of these fundamental value drivers have changed, we are finding that we can use sound analysis to at least bound the range of potential changes in outcomes. At the very least, we are finding that the "right" answer is rarely "Who knows?"

UBIQUITY: What is the right answer?

COURTNEY: Again, the right answer is industry- and issue-specific. But it usually takes the form of "It is impossible to develop a single, reliable point forecast of the future, but by using sound logic and data analysis we can at least bound the range of potential options, and thus develop a strategy that is much better positioned to manage risk and capture new opportunities."

UBIQUITY: Thinking of the high-tech industry in general, do you see much hope?

COURTNEY: Another lesson from 20-20 Foresight, quite frankly, is that you should avoid overstating both what you know and what you don't know! I do not purport to be an expert on the near-term future of the market in general, nor on the high-tech sector in particular. So let me first say that I would be going against my own advice to pretend that I understand exactly where the technology sector is going. On the other hand, I think it is pretty clear to those that follow the sector closely that there probably won't be much good news in the near term. IT infrastructure and other high-tech spending is driven largely by the health of other sectors of the economy. Some of the economy's most important sectors -- manufacturing, travel services, and so on -- are probably headed for a recession (as we traditionally define a recession as two consecutive quarters of negative GDP growth). Earnings shortfalls for companies, income losses for consumers associated with increased unemployment, and the increased uncertainty over future earnings and incomes that we discussed above will all tend to check the demand for high-tech goods in the near term. It's difficult for consumers concerned about impending layoffs to buy new personal computers and it's really difficult for a major chemical company that's announced thousands of layoffs to launch a major IT infrastructure investment program. All that said, our high-tech sector has demonstrated an incredible ability to innovate in the past decade, and I am bullish on the long-term prospects for the sector. We've recovered well from economic downturns in the past, and I don't see any reason to believe that we won't emerge even stronger from this one.

UBIQUITY: Talk about the different levels of risk that you describe in your book.

COURTNEY: While uncertainty isn't binary, it does always take one of four different "levels." For any given strategic decision, there are uncertain variables ("value drivers") that determine whether or not the decision will end up being a good one. For example, when I was looking to buy a new house last summer, the "value drivers" of that choice included the quality of the house's construction, its resale value over the life of the mortgage, interest rates over the life of the mortgage, and so on. For any one of these value drivers, one can ask how much can be known -- given the best possible analysis -- about its future value. The answer to this question will always, without exception, take one of four general forms. These four general forms are what in 20/20 Foresight I define as the "four levels of uncertainty." For example, in some cases -- what I call "Level 1" uncertainties -- you can come up with a reasonably precise forecast for the future value. Of course, there may be some variation around that forecast, but the variation will be small enough so that it doesn't matter for the decision at hand. For example, the real estate market where I bought my house was stable enough that, with a little analysis, I concluded that the resale value of my home could be forecast with enough precision so that this uncertainty didn't matter for making the "right" choice to buy the home or not. It was a Level 1 uncertainty. Likewise, business decision makers often face Level 1 uncertainties when making routine investments in fairly stable, predictable business environments -- ones where good analysis can generate reasonably precise forecasts.

UBIQUITY: What is a level two uncertainty?

COURTNEY: With level two uncertainties, it is impossible to generate a precise point forecast of the future. However, it is possible to identify a limited, discrete set of possible outcomes, one of which will occur. For example, there is often Level 2 uncertainty over pending legal, regulatory or judicial actions -- there is a limited set of outcomes for how California could choose to re-regulate its electric power markets, how the FAA will regulate flights into Reagan National airport, and how the courts will ultimately rule on the Microsoft case. In such cases, you can identify the feasible set of outcomes, but you can't identify ahead of time which one will occur. Similarly, companies often face Level 2 uncertainty over competitive conduct. Will a competitor enter a market or not, build capacity or not, match your price increase or not? All of these questions have a limited, discrete set of possible answers. Uncertainty over industry technology standards is also often at Level 2: Which technology will become the industry standard? Thus, there was Level 2 uncertainty in the early standards wars between VHS and Beta, DIVX and DVD, and CDMA and TDMA around which standard would emerge as the dominant one in the industry.

UBIQUITY: And what is level 3?

COURTNEY: Level 3 uncertainties are similarly to Level 2 in that it is possible to bound the range of potential outcomes. However, unlike Level 2, it is impossible to identify a limited set of discrete outcomes ahead of time. For example, in October 2000 there was Level 2 uncertainty over who our next president would be -- it would be Bush or Gore. One could identify exactly what the potential outcomes could be, but couldn't say which outcome would actually occur. However, there was Level 3 uncertainty around the potential margin of victory. Polls and analyses of past presidential elections could allow one to bracket the range of feasible outcomes on the vote counts (say from 40-60 Gore to 40-60 Bush), but the actual outcome could occur anywhere within this range. That's the difference between Level 2 and Level 3. In either case, unlike Level 1, this uncertainty matters for decision-making and cannot be forecasted with reasonable precision ahead of time.

UBIQUITY: Which brings us to level 4. . . .

COURTNEY: Level 4 uncertainties are those variables that are truly ambiguous -- ones where even the best possible analysis will not enable one to bound the range of potential outcomes. Level 4 uncertainties are rare, but they do occur. For example, I believe we are currently facing Level 4 uncertainty over some of the geopolitical events that will evolve as a result of September 11. Again, some may claim to be able to bound such possible outcomes, but I suspect that there may be no sound fact or logic base to support such claims. At the very least, given the information base that is available to me, I certainly feel unable to bound the range of outcomes that may occur at this macro level.

UBIQUITY: Do you have a different view of the global economy than you did a couple weeks ago?

COURTNEY: As a professional economist and management consultant, it should come as no surprise that I tend to view the globalization of world markets as, generally, a good thing. And not just in economic terms, but also in terms of what it implies for the likely spread of human rights and democracy across the globe. Thus, the recent backlash against globalization -- starting with the WTO meeting in Seattle and continuing through to the World Bank and IMF protests in Washington, and the violent clashes in Italy this summer -- has troubled me. I think the protestors -- as well as many politicians, labor groups, and other stakeholders -- make many important points that will need to be addressed by corporate and government policy makers. However, I worry a bit about "throwing the baby out with the bath water." If, on top of the backlash that is already out there, corporations also feel increasingly vulnerable to terrorist attacks on their overseas operations, then companies may indeed slow their globalization efforts. I think that would be a shame. Globalization needs to be better managed to ensure wealth creation for all stakeholders -- in other words, revised, not reversed.

UBIQUITY: Do you think the backlash will prevent or at least slow down the pace of globalization?

COURTNEY: The forces at work that are driving globalization today -- falling interaction costs, falling tariff barriers, falling language barriers, increased capital and labor mobility, and so on -- all of those trends are so strong and so fundamental that it is hard to believe that they will be reversed. I think the backlash I talked about above may only cause us to rethink the pace and form of globalization in the coming years.

UBIQUITY: As a consultant, have you found yourself giving different advice now than you would have a month ago? Maybe it's too early to ask that?

COURTNEY: I think it is a great question, but to be perfectly honest with you, business has not been "as usual" the last few weeks for anybody -- certainly not for my clients and certainly not for me as a consultant. I don't think any of us have had a chance to really digest everything that follows from September 11 yet. In particular, I would want to avoid offering any flip, one-size-fits-all answer to my clients today when the "right" answer may be extremely complex. It is my firm's job over the next several months to help our clients sort this all out.. I suspect that for many of my firm's clients that this is a tragic, horrific event that influences us all personally, but which probably won't have a fundamental impact on their business strategies going forward. For others, for instance transportation clients, it obviously has an enormous impact on their business strategies, suggesting that the solutions will be very different for different clients.

UBIQUITY: As you express your ideas to clients, do you find anything that people are scandalized by or hate or for that matter embrace with wild enthusiasm? What gets peoples' interest?

COURTNEY: Invariably, people get excited about the notion of "binary uncertainty." Once pointed out to them, they all recognize this tendency to over- or underestimate uncertainty in their organizations and in themselves. And they immediately come to understand the institutional norms that create this bias. For instance, most companies -- large and small -- have strategic planning and decision-making processes that are based on the premise that the world can be forecast with reliable precision. These processes are embedded in business school curricula, in business books, and in the mindsets of most senior managers. These processes "force" decision makers to develop point forecasts of the future when evaluating strategic decisions even when such forecasts are nothing more than guesswork. The only way one can get around these decision-making processes is to make the case that the world is "so uncertain" that a systematic, analytical approach to decision making is impossible. Thus, the incentive to either under- or overestimate uncertainty is institutionalized within the firm!

UBIQUITY: Is this where understanding of the four levels can be useful for making decisions?

COURTNEY: Absolutely. The four levels help you realize that most strategic decisions face Level 2 or Level 3 uncertainty -- where the world is neither completely "certain" nor completely ambiguous. The good news is that there are decision-making tools and processes that allow companies to take systematic, analytical approaches when crafting strategy under Level 2 and Level 3 uncertainty. In particular, this is where tools like scenario planning, game theory, real options valuation, and others must supplement the traditional business strategy and finance toolkit (such as Porter's five forces framework and net present value analyses). In addition to specifying the right toolkit for decision-making, the four levels also often shed light on the best strategy to pursue. For example, "hedging" is a common strategy to address Level 2 uncertainty. For example, if you were a software developer in the late 1980s facing Level 2 uncertainty over which personal computer operating system would emerge as the industry standard, you could hedge your bets by developing programs for Windows, Dos, Apple, Unix and OS/2. Similarly, we have found that, paradoxically, bold, industry-shaping strategies often make the most sense amid the chaos of Level 4 uncertainty. When elements of industry structure and conduct are in such flux, market leaders may help create order out of the chaos by setting industry technology standards, consolidating the industry, or otherwise asserting a vision of the future that others might emulate. We have found a number of such "prescriptions" that help our clients craft strategies when faced with each of the four levels of uncertainty. People can, and do, get excited about that.

UBIQUITY: Let me ask you, without asking you to predict the stock market, to make a prediction about the impact of the current high level of uncertainty on such things as R&D expenditures and investments in education, and for that matter, entrepreneurship and start-up developments.

COURTNEY: In 20/20 Foresight, the chapter entitled "Now or Later?" lays out a framework for thinking about when to make strategic investments such as R&D expenditures, new business ventures, and training when faced with uncertainty. All of these investments tend to have two features -- they are "sunk" once made (you can't recover the R&D expense if the project fails, for instance), and they often can be postponed. Whether you want to postpone or not depends on several factors, but the most important tend to be the level of uncertainty surrounding the payoff to the investment and the threat of competitive preemption or "opportunity cost" associated with waiting. High uncertainty favors postponement because it enables the decision maker to process more information before committing to the investment. For example, the return that a pharmaceutical company would earn on an investment in a potential new gene therapy treatment may depend on uncertain regulatory decisions by the FDA. If the company waits long enough, the FDA's procedures for gene therapy approval may become clear, and it could thus invest with much greater certainty. The downside, of course, is that by postponing its decision the pharmaceutical company may be forfeiting years of potential earnings from the investment to more aggressive competitors that move more quickly. In any event, the high uncertainty in the economy associated with the events of September 11 and the economic downturn in general would, all else equal, tend to drive companies toward postponing major investment decisions. This is especially true given that many companies undoubtedly believe that their competitors will also postpone investments given the high uncertainty in the market, and thus conclude that the threat of competitive preemption on most potential investments is minimal. Unfortunately, in the end I think that this implies that business and personal investment spending will slow down this year -- at least until decision makers come to terms with how uncertain their worlds really have become in light of recent events.

UBIQUITY: What are the risks involved in postponing such investments?

COURTNEY: As noted above, companies that postpone investment decisions today may incur high "opportunity costs," especially when preempted by more aggressive, first-moving competitors. Again, I think many companies currently view this threat of preemption to be pretty low -- they are anticipating that their competitors will be paralyzed by current uncertainty, too. Yet, obviously, this opens up enormous potential opportunities for those willing to "swim against the tide" and make bold, market-shaping commitments today. I would caution most companies to avoid simply falling into postponing investment decisions by "default" given high uncertainty. Instead, determine if there are risks you can take -- despite the high uncertainty -- because today's economy may provide extraordinary opportunities for those that take advantage of others' "decision paralysis." Obviously, such risks are not for all decision makers and all companies. But all companies should at least consider their alternatives.

UBIQUITY: Are there any advantages in the times of uncertainty?

COURTNEY: Absolutely -- and they accrue to the companies and decision makers with the resiliency and capital positions to weather the current storm, along with the foresight to make investments today that position themselves to win in the future. Decision makers often focus exclusively on the threats associated with high uncertainty, but, of course, uncertainty also creates incredible new opportunities. Time and again we've seen that the best time to complete a merger, the best time to build a new plant, or the best time to launch a new R&D program was during a recession. After all, "buying low" is still a good strategy -- especially if it builds competitive advantages for the next upturn. This economy will recover. It always has before, and the fundamentals of our economy continue to be quite strong. No matter what level of uncertainty we face today, we shouldn't forget that.

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