Cover image for Profiting from uncertainty : strategies for succeeding no matter what the future brings
Profiting from uncertainty : strategies for succeeding no matter what the future brings
Schoemaker, Paul J. H.
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New York ; London : Free Press, 2002.
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xv, 267 pages : illustrations ; 24 cm
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HD30.28 .S3455 2002 Adult Non-Fiction Central Closed Stacks

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What manager is not anxious about the future? We live in a white-knuckled age of rapid technological change and global instability. But uncertainty is not the enemy, says management expert Paul J. H. Schoemaker. It is where the greatest opportunities are. To unlock these opportunities, however, requires a very different approach to strategy and implementation. In this pioneering book, Dr. Schoemaker presents a systematic approach that combines concepts such as scenario planning, options thinking, and dynamic monitoring to create novel strategies for profiting from ambiguity.

Building on his experience with more than one hundred consulting projects in fields ranging from health care to manufacturing, from utilities to financial services, Schoemaker shows how major corporations throughout the world have used his pathbreaking methodology to prepare for an uncertain future and profit from it. In this first comprehensive approach to the subject, Schoemaker shows the reader (1) how to develop and analyze multiple industry scenarios, (2) craft nimble strategies with just the right amount of flexibility, (3) implement them using an options approach, and (4) make real-time adjustments through dynamic monitoring. As a leading academic thinker and practitioner, the author draws on the frontiers of decision science, organization theory, strategy, and cognitive psychology to integrate the most practical contributions these various fields have made to navigating uncertainty.

More than any other capability, skill in seizing initiatives in shifting, unpredictable circumstances is the key to success. Profiting from Uncertainty provides a road map to do just that. This book was first published in 2002, well ahead of the mega turmoil that befell the world in 2008 and beyond. The methods and tools described here have been used by many companies and are even more relevant today than when originally published. You can't do without them.

Author Notes

Paul J. H. Schoemaker, Ph.D., is chairman and CEO of Decision Strategies International, Inc.

Reviews 1

Publisher's Weekly Review

Like fossilized skeletons of species past, the carcasses of companies that failed to heed the shifting winds of change litter the landscape of the business world. Strategic planner Schoemaker presents various examples of blindered business outlooks in this guide to making the best of a rapidly changing world. As he freely admits, change is not manageable in the least and is often quite scary. "Uncertainty cannot be pinned down or coaxed into cages. It is only partly tamable, and we must learn to live with the beast." These are brave and true words, and it's to Schoemaker's credit that he states them up front. (Too many business gurus insist that everything can be planned for given a generous layout of consulting fees, of course and easily managed.) Schoemaker's point is that too many companies try to figure out the future by looking at the past (Cisco's sad story is a particularly telling example of this tendency). Of course, the book's litany of mistakes and don't-repeat-this case studies start to seem like just another way of looking backwards into the future. There is some valuable information here, though, as Schoemaker breaks down the scenario-building process and shows readers how to gaze into the crystal ball and plan for not just one, but multiple possible futures. He also addresses the importance of things like simply getting a company's higher-ups to listen to you. Although not groundbreaking, this is a worthy and useful reminder of the danger of resting on one's laurels. (July 11) (c) Copyright PWxyz, LLC. All rights reserved



Preface: Tumultuous Times I was in the midst of writing this book when the events of September 11, 2001, dramatically raised the level of uncertainty in the world, both real and perceived. Following the terrorist attacks on the World Trade Center and the Pentagon, book buyers cleared the shelves of works by Nostradamus in hopes of finding clues as to what might happen next. Most people crave certainty, yet we live in an increasingly uncertain world. Since it is not possible to know much for certain anymore, we must become skilled at sailing into the unknown. It is hard to look uncertainty in the eye without blinking. Three weeks before the September 11 terrorist attacks, I was working with managers from a major property and casualty insurance company on scenarios for their business. There was a heated discussion about whether to include in the scenarios major catastrophic losses from terrorist acts or other disruptions. Some argued that such risks were already priced into the premiums and that adequate reserves existed to cover them. Time will tell whether property and casualty insurance companies, and their reinsurers, were in fact sufficiently well capitalized to absorb the shocks from various catastrophic events. (In November 2001, Warren Buffett blamed a large loss at Berkshire Hathaway on what he called a "huge mistake" by its insurance companies in not anticipating the need to collect extra premiums for terrorist acts before September 11.) But I am sure that we gave it far less weight in our discussions than we would today. Life is inherently uncertain -- from the moment of our birth to the unknown moment of our death -- and yet we hate uncertainty, particularly in business. Business leaders traditionally have viewed uncertainty as the enemy. Skilled management is often seen as the process of avoiding unpleasant surprises. Uncertainty is something to be nailed down and rooted out, an evil that detracts from one's ability to manage with control. Uncertainty creates obstacles for the organization in generating profits and ensuring consistent performance. As managers, we seek to reduce uncertainty. We gather facts and figures. We turn to experts for predictions. We hope to pin down uncertainty like a butterfly in a scientific collection. We use insurance to buffer uncertainty. We use denial to avoid uncertainty. And we put gates around our communities and our lives to keep risk at bay. We long for certainty with such passion that we very often bend reality to fit our desires. Instead of looking at the complex and chaotic soup that is reality, we make up a story, and we stick to that story under cross-examination, no matter how much the facts argue otherwise. We believe that our business is just on the verge of an upswing -- until the movers come in and begin carting out the furniture. We believe our current business model will be successful in the future -- it always has been -- and so we fail to see that the world has shifted and that new competitors have arrived. Uncertainty cannot be pinned down or coaxed into cages. It is only partly tamable, and we must learn to live with the beast. We cannot avoid surprises. Instead, we must be ready for them when they come. We need to be able to manage surprise and roll with the punches. Certainty has never been more elusive than in today's tumultuous times. In recent decades we have lived through shocks such as the fall of the Berlin Wall, the explosion of the space shuttle Challenger, the mapping of the human genome, mad cow disease, Asian financial and political crises, Balkan wars, introduction of the euro, the boom and bust of the dot-coms, electricity blackouts and brownouts in California, and terrorist attacks of various kinds. Technology, deregulation, and other shifts in the global competitive environment continue to reshape the world in unpredictable ways. Some shocks come completely out of the blue. When I was at Royal Dutch/Shell in the 1980s, our planning group in London had anticipated a major shift in the Soviet Union if a rather obscure bureaucrat named Mikhail Gorbachev came to power. But the Shell scenarios completely missed the subsequent fall of the Berlin Wall and its repercussions for the world (as did Gorbachev and most of the U.S. intelligence community). There will always be surprises, and the most difficult uncertainties for managers are those unimagined and those deemed to be possible but unlikely. But while we cannot fully know the future, we can better anticipate and prepare for the possibilities that we can foresee, factoring them into our strategies. The silver lining of our turbulent environment is that we need uncertainty to create profit. Only modest profits can come from taming traditional uncertainty such as life insurance risks. Common risks lead to common returns. Consider the financial markets. If we knew the future income stream of a company for certain, its stock price would be largely fixed. There would be little opportunity to buy or sell at a significant profit or loss. In the end, the opportunity to profit comes from uncertainty. Of course, some companies do earn high profits in environments of high predictability, but these profits are drawn from having a better hand of cards or superior execution, not from mastering uncertainty. However, the vast value created by innovation, through distinctive strategies that set a company apart from its rivals, depends upon knowing how to profit from uncertainty. Profiting, in this context, is different from profiteering. The goal is not to profit by capitalizing on tragedy and hardship, but rather to profit from anticipating different futures and preparing better for them. Such profit can be in the form of money, but it can also take nonpecuniary forms such as universities being better prepared for distance learning, hospitals staying abreast of technological change, and churches anticipating better the evolving needs of their parishioners. The strategies and methods we discuss extend far beyond the for-profit enterprises that constitute our primary focus. Profiting from Uncertainty offers frameworks and approaches that help business leaders prepare for uncertain futures and find opportunities within them. The following pages offer a systematic approach for understanding uncertainty and capitalizing on it. The book is based upon a comprehensive approach -- using scenario planning, options thinking, dynamic monitoring, and other strategies -- pieces of which have been employed by major corporations around the world to think about and prepare for the future. This book shows how these approaches can be used not only to cope better with ambiguity but also to profit and prosper from it as well. Paul J. H. Schoemaker Villanova, Pennsylvania Copyright © 2002 by Paul J. H. Schoemaker Chapter 1: Embracing Uncertainty "The only 'risk' which leads to a profit is a unique uncertainty....Profits arise out of the inherent, absolute unpredictability of things." -- FRANK KNIGHT, UNIVERSITY OF CHICAGO ECONOMIST, 1921 On March 17, 2000, a lightning bolt ignited a fire in Albuquerque, New Mexico, destroying a Philips semiconductor plant. Across the globe in Scandinavia, both Nokia and Ericsson depended on the factory for key chips in their cellular phones, and this chance disaster threatened to choke off their production. Nokia responded fast and flexibly, recognizing the problem thanks to its dynamic monitoring. Even before it was told of the plant shutdown, the company quickly patched together a solution. Ericsson, however, was less well prepared and moved slowly, losing an estimated $400 million in potential revenue, contributing to a corporate operating loss of about $1.86 billion in 2000 and ceding an increasing share of the global mobile phone market to Nokia. As Jan Ahrenbring, Ericsson's marketing director for consumer goods, told The Wall Street Journal, "We did not have a Plan B." Ericsson lost some $400 million in sales -- a serious price to pay for not having a plan B. While it may be easy to understand how managers can be blindsided by a random lightning strike half a world away, this represents one of the simpler forms of uncertainty that managers face. It concerns a known risk with a very low probability and high potential cost -- against which managers can use insurance or contingency planning. The more challenging uncertainties that managers face are those they haven't a clue about -- when they wake up one day to find that the Berlin Wall has crashed to the ground or to recognize that the Internet has emerged or faded as a powerful new market space. Such uncertainties have the potential to create or destroy billions of dollars in market value: Cisco Systems very adroitly surfed the rising tide of the Internet to build one of the most successful information technology businesses in the world. Its market value skyrocketed for thirteen consecutive quarters and by April 2000 topped $550 billion, surpassing Microsoft and General Electric. Investors and managers began to believe it was a sure thing. Cisco, whose sophisticated Web-enabled accounting system allowed it to close its books hourly in a "virtual close," seemed to have the kind of tight rein on its business that would help avoid surprises. But then the tide of uncertainty turned against the company. In 2001 Cisco hit a downturn in the market that it had failed to anticipate. Its backward-looking accounting system turned out to be a highly polished rearview mirror that failed to keep the company from running off a cliff. It was also locked in to contracts and other commitments that made it hard to shift its strategy. Its revenues and share price plummeted over 70 percent, and worse, it had to take a $2.5 billion write-off for excess inventory. Cisco CEO John Chambers compared the slump to "a 100-year flood." He said, "It's something you don't expect to see in your lifetime. We never built models to anticipate something of this magnitude." But had the collapse of the Internet bubble and the ensuing recession really been that unpredictable? Or was the company so caught up in the euphoria of the moment that it had been slow to see the cross-currents swelling just below the surface? Even Nokia, the Finnish wireless equipment maker that grew to become the world's largest manufacturer of mobile phones by skillfully riding uncertain and turbulent market conditions -- and dodging occasional lightning strikes -- found itself blindsided by the ephemeral wireless market. In June 2001 it suddenly halved its forecasts for growth in handset sales, projecting lower second-quarter profits, and its share price fell by 23 percent. Is there any way it could have better prepared itself for this eventuality? The spectacular failure of Long-Term Capital Management (LTCM) in 1997 shows that even the brightest thinkers cannot fully anticipate the future. In this case, Nobel Prize-winning economists teamed up with savvy Wall Street traders using sophisticated computer models, but a future they did not bank on came to pass. They were blindsided by an unusual confluence of circumstances outside their mental frames. The failure of LTCM was also perhaps the result of sheer hubris, an unreasonable confidence in the team's ability to outsmart the market. As this elite team learned the hard way, the market can behave less rationally than their sophisticated models assumed. In the end, trading remains a very human business, fraught with the quirks and foibles that set us apart from machines. So how do you come up with a plan B, and perhaps a plan C, when many uncertainties lurk around the corner? What will allow you to prepare for the lightning strikes or to capitalize on the gold strikes that occur with ever-increasing frequency in today's world? Uncertainty is ultimately the only source of superior profits, yet it entails a highly dangerous game. This game is where tremendous value is created -- and destroyed. How can you profit from the upside of uncertainty while managing the downside? How can you position yourself to win, no matter what the future holds? The point of these examples is not to deride the companies involved for poor planning under uncertainty. It is easy to see the right path today, with twenty-twenty hindsight, when we know for certain what future came to pass; it is much harder to chart the right course in the midst of rapid change and high uncertainty. The point of these examples is first of all to show that the stakes are high. As economist Frank Knight points out in the quotation that opens this chapter, significant profit and loss are found in uncertain times. Cisco and Nokia, as well as other companies such as Microsoft and Amazon, all built tremendous wealth by charting a course across choppy seas that swamped many other boats. When more traditional players -- such as IBM, AT&T, and Sears -- struggled, the new kids on the block seized the opportunity. As 19th-century British banker Nathan Rothschild observed, "Great fortunes are made when the cannonballs are falling in the harbor, not when the violins play in the ballroom." The second point of the examples above is to underscore that often the future that most rapidly undermines a business is the one that its managers fail to see or cannot imagine clearly enough to prepare for. It is well documented in behavioral decision research that we tend to become locked in our current frames, seeing what we are conditioned to see. Cisco may have seen things through rose-colored glasses long after the rest of the world had accepted that the U.S. economy was entering a downturn. As human beings, business leaders tend to be overconfident about their predictions of the future, especially if they have been successful in the recent past. Why is it important to focus on uncertainty? First, it affects the part of the business that managers very often don't even try to manage -- the external environment -- and this is where much of the potential value of the business is created or destroyed. Second, the level of uncertainty in the business environment appears to be increasing significantly. And third, human beings have inherent limitations in dealing with uncertainty. To set the stage for the rest of the book, I'll explore each of these issues in more detail. Leaving Half the Business to Fate While managers concentrate most of their energies on the existing business, the management of external uncertainty may have far more potential for creating value. Studies across a wide variety of industries reveal that firm-specific actions account for just over half the value of a firm. About half of the variance in return on investment is attributable to general economic and industry conditions. As we sometimes note (only half-jokingly) in our executive teaching programs, the surest way to managerial success is to find an industry in the early stage of a spectacular growth spurt and hang on for the ride. From there on, 80 percent of success is "showing up" (as Woody Allen dryly noted) and keeping your nose clean. Many managers view the external environment as something beyond their control, like John Chambers's "100-year flood." But here they often adopt a double standard. They tend to take credit for all the good news (as if they had much more control than they do) and blame most of the bad on the environment (as if they had no control). A study of Fortune 500 quarterly reports found that in good quarters 79 percent of performance was attributed to internal factors -- implying that success was due to what managers did. In bad quarters, however, 75 percent of the blame was attributed to external factors. Managers who can get better at managing this external uncertainty -- learning how to protect against the downside and position for the upside -- can start to harvest that half of the company's value that is otherwise left to the whim of the environment. Cisco's value was not lost because of poor operational management of its existing business. The company was one of the tightest real-time operations in the world, which many other firms sought to emulate. Cisco lost so much of its value because it was unable to effectively navigate the uncertainty of its environment, to see even the possibility of the "100-year flood" that washed it off course. I am not saying that you can control the environment or predict the future. You can't. But all firms can learn how to prepare better for uncertainty and proactively manage the part of the business that they too often leave to fate. There is great leverage in improving how an organization assesses and negotiates the external environment. It will require, however, a change in mindset as well as the mastery of new approaches and tools. In general, managers tend to look backward even though most of the new opportunities and threats for companies lie in the future. Informal surveys by Gary Hamel and C. K. Prahalad suggest that senior managers devote less than 3 percent of their time and energy to building a collective vision of the future. The inherent uncertainty of the future makes people uncomfortable, and for a variety of reasons that we explore later in the book, people don't like to think about it much. Most of us prefer to stay within our comfort zone, which is the past and present. Looking backward feeds the illusion that our world is orderly and predictable; in hindsight things are so much clearer. Just consider where you are focusing your attention: Are you managing the relatively certain current business, or are you anticipating the uncertain possibilities and dangers of the future? Do you have a grasp of where the key uncertainties lie in your industry and beyond so you can profit from them if they occur? Through scenario planning, by placing yourself into the future and looking backward, you can actually increase your capacity to imagine the future. This ability to engage in prospective hindsight is increasingly important as the tide of uncertainty rises. Increasing Uncertainty The rise in uncertainty is driven by a variety of factors. An ideological shift in politics and business from centralized planning toward free-market dynamics is resulting in much more complex socioeconomic systems. In addition, new technologies are accelerating change, often in a highly disruptive way. Furthermore, profound demographic changes and value shifts are occurring. All these forces combined result in much greater complexity. A simple chart of the fluctuations (the spread for each year divided by the mean) of the Nasdaq index indicates a strong increase in uncertainty over the past two decades. Relative volatility -- when measured in terms of range -- rose from 6 percent in 1984 to 74 percent in 2001. Individual stock prices also provide indication of rising volatility. Data collected by Susquehanna International Group, a large private options trading firm in Philadelphia, show that the implied volatility of individual stocks (as inferred from the observed price of call options) has greatly increased over the past decade. A variety of indicators, from decreasing CEO tenure, compressed cycles of technology and new product development, increasing globalization, and regulatory change are also pointing to increased uncertainty. The Nature of Uncertainty It is not just the magnitude of uncertainty that creates challenges but also its shifting nature. There is a wide knowledge spectrum that ranges from certainty to chaos and ignorance. The left-hand side of the spectrum is the most manageable and amenable to analytic approaches. This is where great strides have been made in academia and industry, using such tools as decision trees, Bayesian statistics, expected utility theory, portfolio analysis, and Monte Carlo simulation (see Appendix B). In the middle of the spectrum we encounter ambiguity, for which our present tools and techniques are less well developed. Here we must rely more on creativity and learning than on analytic deduction. The challenge in the middle is less one of computational complexity than of cognition, to make sure that we frame the issues correctly and ask the right questions. Scenario planning, options thinking, and influence diagrams can be especially helpful here, as well as a healthy dose of humility about what is knowable. At the far right we encounter terra incognita, like the prospect facing early explorers who sailed "off the end of the Earth." We don't really have very good tools yet to manage chaos and ignorance. Without a clear structure and good data, it is hard to tackle the problem analytically. And when left to our own devices, we know that humans can easily stumble or be trapped by their cognitive limitations. On the far right, the focus has to be more on generating multiple views, surfacing deep assumptions, and exploring the unknown terrain. Systems dynamic modeling has proved useful here since it helps portray our mental models. Also, the ability to generate and test multiple hypotheses quickly to enhance learning is key. And even more philosophical approaches, such as identifying the nature of our inquiry system or examining the structure of arguments, can help reduce the risk of not knowing. Our modern challenge is that, overall, the world is moving to the right, with higher levels of ambiguity and even chaos in many sectors and industries. The uncertainties at the right end of the spectrum are much more difficult for us to deal with than the definable risks at the left end. The less ambiguity we experience, the more we feel a problem can be structured, managed, planned for, and controlled. But competitors can do this as well, so the opportunity for advantage is diminished. We must learn how to welcome and indeed embrace ambiguity. With ambiguity we face not only the risk of the decision itself but something deeper -- what has been called epistemic risk -- the risk of not knowing. As the world has moved from relative certainty to higher levels of ambiguity, epistemic risk has increased. This environment of rising uncertainty challenges traditional approaches to strategy. The provocative observation by Frank Knight at the opening of this chapter -- that uncertainty is the only true source of profit -- may at first seem counterintuitive. After all, companies derive profits from specialized assets such as brand names, superior products, patents, and efficient manufacturing. Knight, an economist in the 1930s at the University of Chicago who helped shape that institution's distinctive school of economic thought, drew a sharp distinction between risk and uncertainty. In his view, the former can be anticipated and priced in competitive markets -- like life insurance risks -- and thus any profits associated therewith are competed away. Uncertainty, on the other hand, concerns the unforeseeable elements in markets, and by definition those things are not fully priced or factored into a firm's decisions. Assuming a competitive market, in the long run everything gets competed away except these unanticipated aspects. They alone are left when the carnage of full competition is completed. And they alone explain why some firms end up winners and others end up losers, at least according to Knight. This represents a different view of the sources of superior profit than those of the traditional schools of strategy, which focus on structural advantage, operational excellence, or business reinvention. While Knight viewed the ultimate source of profit to be random, beyond the control of companies, this book advances a different view. I propose that firms can shift the boundaries of what they control and don't, through superior anticipation, flexible strategies, and dynamic monitoring. I believe that firms can be favored by chance and that you can design organizations that profit from, or perhaps even create, serendipity. If all firms were to master these skills equally, then Knight is right and only luck would set them apart. But that is unlikely to happen in our lifetime. Our Difficulty with Uncertainty This rising tide of uncertainty -- and ambiguity -- exacerbates some existing human limitations. Humans face some inherent obstacles when it comes to handling uncertainty. Years of behavioral research have identified a variety of pitfalls that we encounter in addressing uncertainty and ambiguity. Our limitations (described in more detail in Appendix A) fall into two broad categories, relating to how we perceive risks and how we act on them. In a nutshell, we tend to have myopic eyes and timid souls. Our myopic eyes see only a limited range of uncertainties out there. Failures of imagination in envisioning future pathways, anchoring on current estimates, and overweighing readily available information all feed our tendency toward overconfidence. We are often "frame blind," meaning that we don't easily recognize our implicit assumptions and we have difficulty challenging our mental models (discussed in Chapter 2). We suffer from skewed attention, giving more weight to the automobile accidents in the daily headlines than to the less visible but more deadly risk of cancer. And we suffer from high sensitivity to context effects, so our answers to questions change based on how the questions are posed. For example, people are much more likely to wear seatbelts if the chance of being in a car accident is expressed as a 30 percent probability in fifty years than if it is expressed as a 0.001 percent probability per trip, even though these statements are statistically equivalent. In addition to our cognitive myopia, we tend to have timid souls, preferring the sure option over a riskier course, even if the expected payoff is higher. One reason is that we are more sensitive to losses than to gains: few of us would volunteer to flip a fair coin for $1,000. This risk aversion persists even if we are offered a sure $100 just for trying. People also dislike ambiguity, preferring a well-defined risk to a better but more ambiguous one. Finally, we suffer from an isolation bias. We look at each uncertainty in separation from others and may not recognize the full portfolio. Many would judge an accountant who invests in bonds to be more risk averse than a business person owning stocks -- until we learn that the accountant is an avid bungee jumper. We seldom look at the whole picture. These limitations of myopic eyes and timid souls mean that we navigate uncertain environments with much the same difficulty that pilots face in flying through rain and fog. We can no longer rely upon our vision and instinct. We need, instead, to turn to more sophisticated tools and frameworks to guide us through the murkiness of uncertainty. These frameworks and tools, described in the remaining chapters of this book, can augment our limited human capabilities in addressing uncertainty. For example, a study of managers who used scenario planning showed that merely laying out alternative scenarios significantly reduced their overconfidence bias. While I refer to tools listed throughout the book, my focus here is not primarily on delving into the technical details of these tools. My goal is to consider the broader shift in mindset, frameworks, and processes that are required to effectively plan amid uncertainty. Managers need to change their view of and organizational approach to uncertainty. Instead of trying to control and master it, they should explore, navigate, and exploit uncertainty when the time is ripe. This is the premise underlying the framework, methodology, and management philosophy expressed in this book. Without this broader context, the specific tools for addressing uncertainty are much less valuable. I describe the available tools in more detail in Appendix B and also refer the reader to Hugh Courtney's book 20/20 Foresight as an excellent starting point for exploring these tools and when to apply them. Why Not Just Trust Your Instinct? Given the difficulty of anticipating the future in an environment of high uncertainty, some managers choose to move forward on gut or instinct. This can be very attractive, because human intuition often lets you cut through a lot of complexity when making decisions. But while this approach may be appealing in an increasingly complex environment, it also presents a real danger. The danger is that our instincts may be wrong. Our instincts, by and large, are based upon our past experiences. This is what makes a seasoned manager so valuable to an organization -- the ability to get right to the heart of the matter and know what to do. To the extent that the future environment will be like the past, our instincts often serve us well. But an environment of disruption and uncertainty makes it very likely that the future will not be like the past. In a changed world, our old instincts and past experience can sometimes be worse than no experience at all. For example, in the September 11 terrorist attacks of 2001, the experience and training of flight crew and passengers all pointed to complying with terrorist demands and not offering resistance. Based on past experience, this was the right thing to do. But the attacks fell outside of past experience. The passengers on the United Airlines flight that crashed in western Pennsylvania realized that they were in the middle of a very different scenario after speaking to family and friends by cell phone. Based on this insight, they were able to take heroic actions to stop the terrorists. Passengers and crew on subsequent flights have also been able to act out of this new experience and change their "instinct" for dealing with threats on board planes. But could this experience and new instinct have been gained before the initial tragedies? This leads us to a very important use of scenarios -- exploring the future in order to develop a new set of instincts. The purpose of developing scenarios is not to pinpoint the future, but rather to experience it. (I cannot stress this enough. Many well-grounded managers still view scenario planning as a process of determining what is going to happen. They reach the end of the planning process with the wrong question: Which scenario are we going to pick? This misses the point of preparing for multiple futures. Scenario planning is not really about planning but about changing people's mindsets to allow faster learning and smarter actions.) The process of developing scenarios is one of gaining experience in a simulated future. Just as you build instinct in stable environments through past experience, you build an instinct about future environments by living through different scenarios. It is similar to what happens to a soldier in boot camp. What if you are lost in the middle of a hostile territory? What if you are under attack? What if you have to make an assault on a secure position? The goal is to hone the instincts of the soldiers. They will never face the exact scenarios they live through in training, but these anticipatory experiences develop their reflexes and skills for the future. An important difference, however, is that boot camp presents a fairly routine set of experiences whereas the scenarios generated through the planning process should be far from routine. When you feel the future deep in your bones, you gain a set of instincts that allow you to respond quickly and effectively to new challenges as they unfold. The process enlarges the repertoire of responses available to managers based on superior pattern recognition. In an uncertain and changing environment, faster learning is the only lasting source of competitive advantage, and scenario planning is a powerful way to accomplish this elusive goal. A Compass for the Future One of the basic laws of cybernetics holds that as the external environment becomes more complex, systems need to become more complex as well to prosper. A simple thermostat, with a basic reactive feedback loop mechanism, can maintain room temperature at the desired level provided the changes in the room's airflow are not too complex. But if many people move in and out of the room, if windows are opened and closed, and if multiple heat ducts are present, this simple device just will not do. The greater aerodynamic complexity in the room will require a more sophisticated control system, with multiple sensors, predictive intelligence, and automated vent controls. What holds for living organisms and machines also holds for organizations. Complex challenges require greater sophistication. Instead of cutting down the world to fit our problem-solving ability, we need to increase the sophistication of our own decision making. It used to be, in the words of F. Scott Fitzgerald, that the "test of a first-rate intelligence" was the capacity to hold two opposing ideas in the mind at the same time and still function. Today we need to be able to hold three or four conflicting views of the world in our collective mind, while still being able to function adroitly. Tools and frameworks can help us in this process. Finding a Compass In his book The Riddle of the Compass, Amir D. Aczel argues that the development of the compass and other navigational tools led to great prosperity in medieval Europe. At the end of the 13th century, with the widespread use of the compass in maritime navigation, "the world saw a dramatic rise in trade, and with it, increased prosperity for maritime powers such as Venice, Spain, and Britain. A single invention -- the magnetic compass -- made this possible." As a pioneer in shipbuilding and applying the compass to navigation, Venice grew from a small fishing community to one of the largest and most prosperous cities in western Europe, with a larger population than the city of Paris. The compass opened the door to the Age of Exploration, as explorers such as Columbus and Magellan were able to make their way across uncharted seas around the globe. Like these early explorers, managers today face uncharted seas. Unprecedented technological innovations, global geopolitical threats, and economic swings may cause some managers to hug the coastline. They may fear, with good reason, that it is too dangerous to chart a bold course across those choppy seas. But with the right tools, we have an opportunity to move ahead confidently and dynamically into the unknown, even without a fixed set of stars to point the way. The approaches presented in this book -- including scenario planning, key success factors, robustness analysis, strategic vision, options thinking, and dynamic monitoring -- are intended to serve as a new compass for navigating today's uncertain business environment. The Nuclear Age and the Rise of Scenarios Scenario planning arose in response to increasing complexity and uncertainty. It is perhaps not surprising that the first awakenings of scenario planning were by-products of one of the most complexity-fraught initiatives of our age: the Manhattan Project. The development of nuclear weapons posed some of the most tangled technological and moral challenges ever faced by our civilization. Even the science involved was far from straightforward. In 1944 some scientists feared that detonating nuclear weapons might ignite the Earth's atmosphere, sending the entire planet into fiery oblivion. This in itself was a troubling scenario, but as the scientists struggled with it, they realized something even more frightening: they could not determine the chance of this happening. They first tried to solve the problem through analytic means, by trying to work out very complex heat exchange equations, but this approach proved intractable. So instead they turned to a set of simulation models and subjected them to different inputs. In effect, their computers calculated millions of different futures and based on this they concluded that the probability that the atmosphere would burst into flames was very low. Fortunately for humankind, they were right. Like large-scale computing, which was originally created to determine ballistics trajectories, the tools created for the military were soon churning away at peacetime applications in business. Herman Kahn at the RAND Corporation is credited with applying social systems theory to create the first scenarios for the future. The Club of Rome issued dire scenarios of ecological and population disasters that riveted attention and reshaped public opinion. Pierre Wack established Royal Dutch/Shell as a center for the development and dissemination of corporate scenarios. Shell has used scenarios since 1969 as part of its process for generating and evaluating strategic options, helping to make the company consistently better in its oil price projections than other major oil companies. Applications of scenario planning have since been wide ranging in business and politics. Articles by Pierre Wack, Peter Schwartz's The Art of the Long View, and a variety of other works have excited managers about the prospects for using scenarios in their own planning. But the actual practice of building scenarios is much more problematic, and the ability to integrate them into a systematic planning process for creating, implementing, and continuously updating strategy is particularly difficult in large organizations. A Systematic Process I had the pleasure of working with Arie de Geus, Kees van der Heijden, Peter Schwartz, Pierre Wack, and other leaders of scenario planning at Royal Dutch/Shell during an extended sabbatical from the University of Chicago in the early 1980s. As I later helped other companies with scenario-based strategic planning, however, I came face to face with the challenges of transferring this process beyond Shell's gifted individual practitioners. Over time I developed a more systematic framework for building scenarios and integrating them into an end-to-end process for strategy development and implementation. Scenarios are just part of a more extended framework for exploring what it will take to win in the future and for implementing those strategies effectively. Scenarios also are only a means to an end. While they can be as captivating and creative as an engrossing novel, we need to be careful. Sometimes, in the heat of the process, managers become enticed by a given view of the future. They use scenarios to predict the future rather than exploring multiple futures. This is why disciplined analysis and multiple perspectives are so important in this process. Like Ulysses, we need to listen to the siren song of the future but tie ourselves to the mast so we don't end up on the rocks of one scenario. Accepting any given scenario as the future -- or making the pursuit of a single future your goal -- is the surest way to end up stranded in the wrong future. For the process to work, both imagination and discipline must be combined. The broader approach described in this book incorporates scenarios into a framework for understanding the strategies we need to pursue today to be successful in the future. We use scenarios to envision the future and embrace uncertainty. We then identify key success factors across the various scenarios and use them as a basis for a strategic vision. The vision in turn is used to generate strategic options. Managers then continue to monitor the ever-changing environment to test and adapt their strategies, and finally they effectively implement the strategies and options. This, in a nutshell, is how managers can profit from uncertainty. My approach is more than a process for planning. It entails a profound shift in perspective. Managers often see uncertainty as an evil that detracts from an organization's ability to generate profits in the future. Companies have spent millions of dollars on gathering the information they need to reduce uncertainty. They base their investments on net present value calculations or hurdle rates that assume the world will be reasonably predictable, even in the face of solid evidence that it will be highly uncertain. We continue to look for Newtonian precision in a Heisenberg world of quantum uncertainties. (There are, however, promising developments in how organizations address risks and uncertainty.) Instead of trying to fit this complex world into a narrow box -- essentially lopping off complexity to make it fit -- my approach takes complexity and uncertainty as a given. First you ask the question: What are the key uncertainties in our business? Then you immediately ask: How can we profit from those uncertainties given our existing strengths? Uncertainty is no longer the enemy. You aren't asking how you can respond to the threat of the Internet -- or beat back the invasion. You instead are asking what new doors these developments open and how you might go through them. On the following pages, I'll explore this path to profiting from uncertainty in more detail. Chapter 2 offers an overview of the process through the examples of a small German travel agency that used scenario-planning insights to become a major travel software firm. I will introduce you to leaders of The Miami Herald so you can see how they reshaped the strategy of a large, established firm to meet the technological and demographic shifts in its region. In Chapter 3 we'll look at the development of scenarios by exploring how the manager of a pharmaceutical firm might wake up in two very different futures. In Chapter 4, using a discussion of polar explorers, I'll examine what companies need to pack for their journey (Key Success Factors for the future) when they can't be sure where they will land. In Chapter 5 we'll examine how these scenarios and Key Success Factors can form the basis of a coherent vision. We'll explore the challenges Monsanto faced with its bold vision of a shift to life sciences. In Chapter 6 we'll discuss how an online startup in the utilities business kept its options open in an environment of change. We'll then explore how companies can create and assess flexible strategic options. In Chapter 7 we'll meet with leaders of a successful options-trading firm, who have built a profitable business by recognizing patterns in the environment better than their peers. We'll consider a variety of approaches for dynamic monitoring. In Chapter 8 we'll examine strategies and pitfalls of implementation, drawing upon the experience of a number of companies, including DuPont and Royal Dutch/Shell. Finally, in Chapter 9 I'll pull all these approaches together to look at how the board and top management of the Hughes Aircraft Employees Federal Credit Union redesigned their business, their vision, their capabilities, and even their name to fly through the turbulence of defense downsizing, technological revolutions, and financial services deregulation. In an environment of increasing ambiguity, the risks of ignoring uncertainties are greater than the risks of tackling them head-on. And the rewards of actively addressing and mastering uncertainty may be greater than ever. More than any other capability, the skill of addressing uncertainty is one of the key metacompetencies companies need to achieve future success. It will help ensure that you are prepared when that lightning bolt of opportunity or disaster descends from the heavens, as it surely will at some time or other in the future. Copyright © 2002 by Paul J. H. Schoemaker Excerpted from Profiting from Uncertainty: Strategies for Succeeding No Matter What the Future Brings by Paul Schoemaker, Robert E. Gunther All rights reserved by the original copyright owners. Excerpts are provided for display purposes only and may not be reproduced, reprinted or distributed without the written permission of the publisher.

Table of Contents

Preface: Tumultuous Timesp. xiii
Chapter 1 Embracing Uncertaintyp. 1
Chapter 2 Preparing the Mindp. 24
Chapter 3 Experiencing Multiple Futuresp. 40
Chapter 4 Preparing for the Unknownp. 67
Chapter 5 Building a Robust Strategic Visionp. 92
Chapter 6 Creating Flexible Optionsp. 114
Chapter 7 Dynamic Monitoring and Adjustmentp. 139
Chapter 8 Implementation: Living with Uncertaintyp. 172
Chapter 9 Case Study: Flying through Turbulencep. 198
Conclusion: Navigating the Futurep. 219
Appendix A The Psychology of Uncertaintyp. 223
Appendix B Uncertainty Tool Kitp. 232
Notesp. 243
Indexp. 261