Strategy Formulation "In an Unknowable Universe"

Eric Beinhocker, a fellow at the McKinsey Global Institute (a "think tank," in the oddly quaint but apt phrase), is out with what may be one of the most provocative books on economics in several years—though admittedly I haven't even seen a copy yet.  "The Origin of Wealth:  Evolution, Complexity, and the Radical Remaking of Economics," essentially discards the physics-like analogies of classical economic theory, premised on a closed system eternally in search of equilibrium, where change is assumed to be an exogenously generated disruptive shock, for a biology-like analogy of internally-generated evolutionary change and complexity.  As one early reviewer put it:

"[H]e outlines an open, adaptive system with interlocking networks that change organically, reflecting the interaction of technological innovation, social development and business practice. Wealth is created to the degree that this interaction decreases entropy in favor of "fit order" that meets human needs, desires and preferences."

In an excerpt over at HBS' rich Working Knowledge site, Beinhocker explains what applying this template to the exercise of strategy formulation might mean.   To paraphrase, the challenge is how to create strategy "in an unknowable universe."

Strategy formulation is a favorite topic of mine, because I view it as both absolutely indispensable and typically botched—or, to be more diplomatic and probably more precise, misunderstood.  As I've noted, it's not an exercise ex cathedra intended to produce a document for the ages, but rather a continuous discipline of being truly attentive to the marketplace and the larger economic and legal environment, and ensuring that your firm is light enough on its feet to respond to perceived potential opportunities with agility.

What is "the marketplace?"  Actually, there are two that really matter to your firm:  The "supply" marketplace of law school graduates, lateral recruits, and conceivably merger partners; and the "demand" marketplace of clients and industry sectors.  An example from each:  Given that the number of lawyers in the AmLaw 100 has roughly doubled in the past ten years, while the number of graduates from, say, the top 30 law schools is essentially unchanged, what are you going to do differently about recruiting first-year associates?  Or, what does the ascent of the biotech industry mean for your practice group mix?

As far as responding to potential opportunities:  I'm of the view (so, evidently, is Beinhocker) that it's smarter and more effective and safer to place a large number of little bets rather than a few big bets.   As he puts it:

"Rather than thinking of strategy as a single plan built on predictions of the future, we should think of strategy as a portfolio of experiments, a population of competing Business Plans that evolves over time."

Another way of thinking of this "population of competitors" is as a portfolio of options—and I expect, and hope, that Beinhocker's book will be devoured by professional investment and money managers.  

But let's make this concrete, which is exactly what Beinhocker does with a fascinating retrospective analysis of what Microsoft did between 1987 and 1990 as MS-DOS came to the end of its natural technological life-cycle and the next generation of multi-tasking, graphically-oriented Operating Systems were vying for supremacy.

Start simply by recalling that while the Galactic Redmond Empire seems firmly entrenched today, in 1987 Microsoft was a relatively minute $346-million company looking down the barrel of at least three well-funded and hitherto successful competitors:  Apple, with its elegant and very well-received Macintosh; IBM, feverishly working on OS/2; and a consortium of AT&T, Xerox, Hewlett-Packard, and others, pursuing a new flavor of Unix for the desktop PC.

Beinhocker takes over from here (emphasis supplied):

"We can imagine the options that Microsoft faced at this point. Option one: Gates could make an enormous "bet the company" gamble by investing in building a new operating system called Windows and attempt to migrate his base of DOS users to the new standard, ideally before a competitor would reach critical mass with its own system. Option two: He could exit the operating-system part of the market, cede that to his larger, better-funded competitors, and instead focus on applications for which Microsoft's small size and nimbleness might be more of an advantage. Or, option three: He could sell the company or otherwise team up with one of his major competitors. While Microsoft would lose its independence with option three, such a move would probably tip the balance of power in favor of whichever company he chose to partner with.

"All these options would involve big commitments to hard-to-reverse courses of action and involve major risks. The conventional wisdom is that Gates chose option one, and the big bet paid off, enabling Microsoft to continue its dominance of desktop operating systems and spend the next decade fighting antitrust regulators. But that is not actually what happened. What Gates and his team did was much more interesting—they simultaneously pursued six strategic experiments."

In other words, rather than consulting the usual Delphic oracles (McKinsey, to be sure, among them) for the one unitary vision of the future, Microsoft launched a series of  competing business models and watched their adaptive success, reflecting twists and turns in the computing marketplace, until it became apparent that Windows 3.0 had evolved into the most "fit" and deserved prominence.

The temptation from nearly 20 years on is to ask, "How hard was that?", but at the time Microsoft took it on the chin from investment analysts, the business press, and even some of its own baffled employees.  "Can't Gates make up his mind?"  "How can I be competing with a group down the hall?"  "Microsoft has no strategy; it's adrift."

In my experience, the only way to make the strategic exercise real, to give it meaningful traction on the front lines, is precisely to prepare for an array of uncertainties.  Rather than declaring, "It would be great if we could acquire Firm X," learn everything you can about Firm X (and ideally Firm Y and Firm Z as well) so that if it looks as though Firm X would entertain an overture, you have already analyzed and envisioned what that would mean and are in a position to move faster than anyone else.

This Beinhocker story explains what I'm driving at:

"I once worked with a very gruff, pragmatic senior executive who claimed not to believe in strategic planning, saying that it was a bunch of "pointy-headed nonsense." He was also very successful. [...] One day, I saw the advance materials for a strategic planning off-site and noticed that the analyses prepared by this executive and his team were by far the best in the binder.

"The next day, I asked him, given that he had claimed not to believe in strategic planning, why he and his team had put so much effort into the analysis. His reply was, "I don't believe in planning. I do this so that we have prepared minds."

The only trouble with this is that it's hard work.

More than hard work, it requires you to get your senior people together for day-long mano a mano sessions discussing their alternative visions of the future.  Those discussions:

• need to proceed from facts and figures, not just opinions and predispositions;
• and that background material should be assembled and prepared by the senior people; while underlings and consultants can help, the selection and presentation of what's deemed relevant needs to be done by the decision-makers themselves; and lastly
• the ultimate purpose is to learn. It's not to decide on budgets or proposed headcounts; it's to explore, debate, analyze, and ultimately to generate a population of experimental mini-business plans you can unleash into the ecosystem and see which grow and which wither.

After all, it's biology, not physics.