Hugh Courtney’s book, 20/20 Foresight: Crafting Strategy in an Uncertain World, was published the day before the terrorist attacks of September 11, 2001. As the economist and former McKinsey associate principal recalls, in the following weeks interviewers often asked him, “Does this change everything? Is this stuff still valid? The world is so much more uncertain.” Says Courtney, “The honest answer then was that the only thing that had changed was our perception of risks and uncertainties that were always there. And it’s the same answer I give today about the current global business and financial situation.” One of Courtney’s contributions to the literature of strategy was a four-part framework to help managers determine the level of uncertainty surrounding strategic decisions. In level one, there is a clear, single view of the future; in level two, a limited set of possible future outcomes, one of which will occur; in level three, a range of possible future outcomes; and in level four, a limitless range of possible future outcomes. Courtney, an associate dean of executive programs and professor of the practice of strategy at the University of Maryland’s Robert H. Smith School of Business, discussed the relevance of this idea in a recent interview with the Quarterly.
The Quarterly: How do you evaluate the level of business uncertainty today?
Hugh Courtney: The financial crisis has actually brought greater clarity because it has forced us to recognize that we have a lot more level three and level four situations than we would have admitted a few months ago. They probably were there all along, yet the bias was toward thinking that issues were more at level one and level two. Specifically, we have learned how interdependent our financial markets are and how systemic failure in any important node of the network can work very rapidly through the system and bring liquidity to a halt. So our scenarios about the availability of capital around the world have changed significantly.
Maybe the world and the uncertainties we face haven’t changed all that much as a result of the financial crisis, but our perception of risks has. That means there is a real opportunity to rethink the way we make strategic decisions, the way we plan under uncertainty. We should realize that, across sectors, for most important decisions we’re actually pretty far to the right—levels three and four—in the uncertainty spectrum.
The Quarterly: What does that mean in practice for managers?
Hugh Courtney: Level four situations are, by definition, ones for which you can’t really bound the range of outcomes, because it’s anybody’s guess. I’m sure we’ve all felt a little bit of that in the last few months. So the question is, do you just have to wing it? Is that what strategic decision making comes down to? I don’t think that’s true at all, but level four does require a different mind-set.
From level one to level three, the presumption is that you can do some bottom-up analysis. You can figure out what the value drivers are and do some market research and some competitive intelligence. All this may not give you a precise forecast, but you’ll be able to bound the outcomes somehow. That’s impossible in level four situations, by definition. There’s just stuff that’s fundamentally unknowable—truly an ambiguous world.
On the other hand, that doesn’t mean you can’t be rigorous in thinking through strategic decisions in level four. It just requires you to work backward from potential strategies to what you would have to believe about the future for those strategies to succeed. The classic example would be biotech—early-stage biotech investments have always faced level four uncertainty, because you’re playing with therapies with an ultimate commercial viability that is unknown.
The Quarterly: How does that play out?
Hugh Courtney: You could ask, “What’s the return on investment of starting up a lab in this particular therapy?” The answer would be, “Who knows?” Honestly, no amount of analysis would allow you to bound the ROI. But say you told me the following: “We’re thinking about investing in a lab to work on a therapy. The lab’s going to cost $10 million. Should we do it?” Of course, I could say, “Well, I don’t know.” But I could also work backward from that $10 million investment and reply along these lines: “Say you need a 15 percent return on that investment. I can develop a scenario about the conditions needed to achieve this—what you would have to believe about the probability of finding a viable treatment, the amount of time it would take to get to market, the physician uptake rate on that treatment, the compliance rate of patients over time, what you’d be able to price it at, for how long, and how long you’d have patent protection.” I could tell you all that. In fact, I could give you a range of scenarios, all of which will give you that 15 percent return.
Now, the reason that approach would be useful is that even though I can’t do any bottom-up analysis, I can look at analogies. There’s a whole history of drug development, and I can at least place those scenarios within the range of other outcomes in the past. Then I could tell you, for example, “We know now that this project would have to be the most successful drug launch in history to earn the return you want on that $10 million. I can’t say whether it’s going to play out that way, but are you willing to roll the dice given those odds?” Alternatively, “Hey, it only has to be as successful as the median drug-discovery process.”
In other words, you can think about a level four problem in a very structured way. It’s just that your mind-set has to change from a bottom-up analysis based on the value drivers to one based on what we know from similar situations in the past. You don’t have to wing it.
The Quarterly: Let’s say I’m a strategist for a financial-services company. How should I think about today’s uncertainty?
Hugh Courtney: This is a really interesting time because it provides unprecedented opportunities for the survivors. I think the fundamental strategic issues are whether there will continue to be benefits of scope and scale in financial services and whether there will be a big pure-play investment-banking industry in the future.
We learned very well with Glass–Steagall1 reform that the benefits of scope and scale are highly dependent on regulatory structure—that is, what you’re allowed to do with that scope and scale. For example, regulations will influence to what extent scope and scale will give you preferential access to low-cost capital, as well as how much you’re able to leverage and what you can and can’t do to hedge risks. And that’s why even the healthiest financial-services players today face tough strategic choices: they have the opportunity to make bold scope- and scale-building plays, yet the payoffs are highly reliant on future regulatory decisions that are up in the air.
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