Management guru Peter Drucker said one of the key questions strategists must answer is: “What do we have to do today to be ready for an uncertain tomorrow?”  Some companies place big bets on a single vision of the future — on specific products, customers, services or technologies. That’s a good idea, based on research showing that bold, distinctive strategies correlate with exceptional profits. But such bets can turn out to be wrong — not because they weren’t entirely reasonable but because the market zigged when it was expected to zag. It’s tough to predict the future.
So being bold can equip you to win big, but it can also set you up to fail big. This is the “strategy paradox” documented by Dr. Michael Raynor of Deloitte Consulting LLP, in his book of the same name.1 There is a way to adopt a bold plan and yet manage the strategic risk that comes with it. Raynor describes a model in which operating divisions commit to extreme strategies designed for success, while the corporate office creates strategic options that both hedge the downside and create exposure to promising upside opportunities. This allows a company to aim for the returns that accompany commitment, but at lower levels of risk. Strategic Risk and Return: The same, yet different The trade-off between risk and return is familiar to students of finance, but it has gone unnoticed in the field of strategy. Now that we can see it, the critical role of finance professionals can begin to emerge. Options are a valuable tool in the management of financial risk. They are a high-leverage instrument that creates the right, but not the obligation, to acquire full ownership of assets with an uncertain future value. Strategic risk is the same, yet different. Corporations can create high-leverage real options through a variety of investments in assets or capabilities that might be needed by operating divisions to adjust their strategies in ways that mere organizational adaptability does not allow. For example, can Microsoft enhance its position in the operating system (OS) business when, according to some estimates, it has more than 90 percent of the OS market in personal computers? What alternate market might Microsoft bet on? To cover several possibilities, Microsoft has assembled a portfolio of strategic options through initiatives in consumer electronics (Windows CE), mobile devices, (Windows Mobile), gaming platforms (X-box) and online services (MSN). Each of these have growth option value that, independent of the OS business, can create value for Microsoft’s shareholders. But each also has strategic option value. Each is a small investment (compared with the value of the OS division) that creates the right, but not the obligation, to pursue OS opportunities outside the PC context. The Role of Finance: Different, yet the same As a finance executive, you can help your organization identify and manage the strategic uncertainties it faces. Managing financial risk requires the collection and analysis of hard data and the application of proven models. Strategic options offer no such appearances of specificity. The future uncertainty of strategic landscapes cannot be modeled by anything as convenient as the historical volatility of equity prices. But the similarities are more important. A key ingredient for managing strategic risk is quantifying its financial impact. This goes far beyond the sensitivity analysis that is already a common feature of financial projections. It requires identifying the underlying assumptions behind each operating unit’s competitive strategy, determining how much value is at risk should alternate scenarios materialize and calculating what it would cost to create the strategic options needed to manage the risks. Beyond internal modeling and valuation lies the opportunity to help define the vocabulary for discussing the value to shareholders of the lower risk, higher return strategic postures made possible through the application of these principles. For example, financial analysts have in many instances been trained to focus on and react strongly to announcements of quarterly earnings. This is seen by many as pathological “short-termism.” It persists, perhaps in large part, because many organizations lack a way to discuss the uncertainties of the future without appearing directionless and ignorant. In contrast, a clear-eyed description of the strategic uncertainties the company faces and a robust quantification of the investment being made in mitigating them, along with the upside potential created, can go a long way to giving companies the breathing room they need to execute their long-term strategies. 1The Strategy Paradox: Why Committing to Success Leads Corporations to Failure (and What to Do About It), Michael E. Raynor, Currency Doubleday, 2007 This publication contains general information only and Deloitte Consulting LLP is not, by means of this publication, rendering business, financial, investment, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte Consulting LLP, its affiliates, and related entities shall not be responsible for any loss sustained by any person who relies on this publication. | 
