The traditional process of strategy formulation normally begins with an analysis of the external environment; then the characteristics of the organization, then possible courses of action and, finally, how to implement the selected alternatives. Although this process may be logically correct, it means that a lot of the time and resources allocated to the process are used up in the first two phases, leaving the last two as a consequence of the analysis. Perhaps the lack of attention to strategic action is due to a lack of awareness, or the complexity of its concepts. As a result, many observers conclude that the field of strategic management is somewhat removed from organizational ¡ction and a company’s day-to-day activities.
The same argument can be made about execution activities, which up until recently (Kaplan and Norton, 2001) were taken into account only when the first three phases of analysis were complete.
The purpose of this article is to review the basic concepts that have been proposed to evaluate strategic actions, and to propose that these concepts be used more widely so that strategic action is more relevant in the day-to-day life of the organization. This is a simple question of priorities: it is the strategic actions (and their execution) that ultimately affect the organization’s performance. In this text, we propose some guidelines for analyzing strategic actions based on concepts that have been developed in this area, and we recommend that, except in cases where the strategic formulation process is being undertaken for the first time, they be used for an annual strategic review.
The actions taken by an organization can be seen as strategic actions or operating actions. Operating actions are those taken to follow an established procedure within the framework set for the organizational strategy; for example, procurement of raw materials, payrolls, manufacturing a product, or serving customers. Strategic actions are those that modify the administrative system, resources and competencies, competitive advantages, domain, mode of growth or performance objectives. In some companies, the difference between operating and strategic actions is recognized by allocating some resources to an operating budget an others to a strategic budget. This company’s strategic budget can be seen as the money it puts into changing the company; for example, changing its market share or adopting new directions, new markets, new business resources and models.
We find the distinction made by Mintzberg (2007) between intentions and realized action to be useful. These are different, because there are intentions that are never carried out and there are realized strategies that are never premeditated. In other words, there is an ongoing process of learning on the go, which modifies intentions during the realization phase, because internal and external conditions change, sometimes quickly, and over time important elements that were not initially taken into account come to light. We can distinguish, then, between actions that were planned or unplanned, and actions that were carried out, or not:
Deliberate actions are planned actions that are effectively carried out. The primary learning took place before the actions.
Detained planned actions are actions that were planned but ultimately were not completed due to changes in circumstances or priorities, or because something was learned during the implementation process that was not known earlier.
Emergent actions are actions that are carried out but were not specifically planned in advance. The learning took place during the execution in the rehearsing the action. The action is modified during the process.
Truncated emergent actions are those that begin being carried out without planning and are halted, perhaps because of poor results; these are failed experiments. The learning took place during the execution, but the decision was made to curtail the action due to poor results, lack of resources, lack of policy support, etc.
The concepts in which we can see the application of these ideas are as follows: the portfolio of strategic actions, the phases for formulating strategic actions, the degree of commitment to an action, and real options. At the end, we offer some general recommendations on the way to model a system of strategic action.
The Portfolio of strategic actions
Here we present a classification of strategic actions by their impact on the organization’s performance goals, domain, competitive advantages, resources and competencies, mode of growth, or administrative system.
Performance objectives.In terms of their impact on performance objectives, strategic actions can be divided into those which change the level, growth or trajectory of organizational financial performance, including changes in revenues, costs, profits, returns, risk and values. Changes in the relative weight of current performance with respect to future performance are important. It can also help to have an idea of the degree of leeway or financial flexibility that the organization wishes to maintain given uncertainty in its environment.
Domain. Actions relating to the organization’s domain include those carried out on the current domain, market expansion, product diversification, business models, technologies, and vertical integration.
Current domain. Includes actions to change the size or appeal of the current market and the company’s market share.
Market expansion. Encompasses actions to expand or shrink the geographic domain of the business and actions to enter or withdraw from given market segments in the same geographic domain. Some actions result in a larger coverage of the market and others in a closer focus on certain segments or areas.
Vertical integration. Upstream vertical integration means entering a new industry, where the company’s current suppliers operate. Downstream vertical integration means entering a new industry in the next phase of the production process or the company’s distribution channels.
Product diversification. Includes actions to increase or reduce the range of products offered, which may be in the same line or represent new product lines. They may be within the same chain of productive activities, with the same competencies and technology, with the same resources or the same business model, or they may seek changes in these dimensions.
Competitive advantage. Strategic actions frequently seek to change the capacities and positioning of the business with respect to its peers, through the following aspects:
Changes in the benefits perceived by the customer or the customer’s willingness to pay for its products compared to those of its competitors or peers. The company may try to position itself in a different cost-differentiation combination than its rivals.
Changes in prices, credit or collection scheme for the product or service.
Changes in the cost or efficiency of the company’s activities.
Changes in distribution or availability of the product or service.
Changes in image and likelihood of product purchase, attained through promotional efforts.
Actions taken to change competitive advantages may be made in response to similar actions by competitors, or at the company’s own initiative. In the case of competitive reactions, the company may seek to surpass, equal or reduce the impact of rival actions.
Resources and competencies. These include changes in the efficiency of the utilization or leverage of current resources (physical, financial, technological and human), the development of new resources for potential utilization in the future, and acquisition of new competencies with existing resources or those that may be developed in the future.
Mode of growth. In this category we normally find acquisitions and divestitures, organic development, and joint ventures.
Administrative system. This may include: changes in the organization’s corporate governance (who has the authority and responsibility for making decisions), changes in top management team and its coordination, changes in the chain of command (centralized or decentralized), changes in organizational structure (by functions, geographic areas, product lines, matrix or hybrid); changes in information system and incentives, changes in strategic planning and organizational learning system, changes in corporate values and philosophy, and others.
We recommend preparing an inventory of the portfolio of past, current and intended strategic actions. Some of the questions that arise from this diagnosis are:
Does the organization carry out enough strategic actions? Is there a certain paralysis or sluggishness in action? Does the organization do too many things at once?
Are actions focused on a certain issue (objectives, domain, etc.)? How dispersed or focused are it strategic actions? Are they consistent among themselves? Are performance objectives consistent with domain goals? Are domain goals and competitive advantages consistent? Are competitive advantages consistent with resources and competencies? What new resources and competencies must be developed to sustain a strategy? Are the resources and competencies consistent with the administrative system?
What actions does the company not want to carry out? Why not? Does this decision fail to take advantage of resources and competencies, or the administrative system?
Are current actions consistent with past actions? Are they consistent with future actions? Why? Is this what we want?
What results have the actions brought in the past? What type of action should be evaluated more carefully?
Phases of an action’s development
Phases of an action’s development
Creation of an original concept. The original idea may be a combination of previous ideas generated by an executive, employee or client of the company, either individually or in a group.
Development of a formal proposal. Normally, the development of a formal proposal requires some executive to sign off on it, so that the financial organizational resources can be devoted to it, because these resources, not to mention time, will be consumed. It may require market research or technology, etc.
Modification and consensus gathering. The proposal may be modified to meet the needs of affected or interested participants, so that it can be approved. This would take place through a process of negotiation.
Announcement of the decision. This happens once there is a consensus among executives with decision-making power, or when the appropriate executive committee or Board of Directors approves the action.
Initial investment. Resources are allocated before the ideas are put into practice, in order to build facilities, acquire assets, sign contracts, etc. Many times, the action is taken on a pilot basis in one division, product or market, in order to learn from the results before applying it in a general manner to other products, markets or divisions.
Operation and later investment. The proposal begins operating and is modified, expanded or scaled back, depending on the results of the learning.
A similar process can be seen in Bower and Gilbert (2005). We recommend performing a diagnosis of how many strategic actions the company has in each phase of the process, and how many actions go on from phase to phase. Comparing the number of actions in the early phases and in the later phases indicates the company’s degree of strategic maturity. A company with a few actions in the early phases does not innovate much, and its future may be in jeopardy. Some questions that arise from this scheme are the following:
How many actions or projects are there each phase of the process? How many projects go through the process in a given time, for example in one or five years? Is this strategic process effective?
Do enough projects pass from one phase to the other? Are too many filtered out? Do too many make it through? Is the strategic effort diluted in too many directions?
Are there enough ideas on new concepts to choose from? If there are few ideas, why does this happen? Is the company in a mature industry in which there are no longer many opportunities, or have the creative personnel given up because it is too hard to push new ideas through the system? If there are a lot of ideas, is this a good thing? Is it necessary to limit the generation of ideas in the company?
What actions are planned in the organization? What actions are not planned? When is it better to learn before acting and when is it better to learn on the go? Is more planning required? Should emergent actions be encouraged more?
What scheme is used to generate formal proposals? Is a person or group assigned to be the official critic, or “devil’s advocate?” Are two different groups assigned to develop similar proposals? Is the current system appropriate? Should it be made easier or more difficult? What incentives do the people with the winning proposals have?
Is the process of consensus gathering to political? Do some group defend its ground by vetoing proposals that could affect it? Are new projects subject to excessive restrictions?
Our only project with guaranteed success approved? Are the criteria for approval of new actions clear enough? Is it possible to carry out experimental actions with a high probability of failure? Is it necessary to make political concessions to certain groups to obtain approval? Are these concessions reasonable?
Are sufficient resources assigned to carry out new actions? Does the organization learn from and modify the project or proposal on the go or does it stick rigidly to what has been approved? Is control over the resources so closely held or so complex it is difficult to accelerate or stop the process? Is it possible to back down on a project, or is it politically unviable?
What is the new project’s risk of failure? Is success acceptable, or unforgivable? Is failure acceptable, or unforgivable? Could it cost the person who proposed it their job? Are there ways to change the project, expanding it, accelerating it or scaling it back, according to the initial results?
How can organizational efficacy be improved so that more actions are deliberate and emergent?
Commitments and options
For our purposes, we can classify strategic actions into two types: commitments and options. Commitments are major investments, difficult to go back on, which attain the desired objective under a certain future scenario. Options are tentative investments but leave the door open for other future investments and that can generally be abandoned. The company may invest in options to hedge the risk that the scenario will be different from what it expects. Commitments are major bets in which much can be won, or much can be lost. Options are minor investments that allow the company to maintain flexibility by building up capacities that may be useful in the future. If the future is as expected, the company can invest more and profit from it; if the future is not as expected, it will only have lost a minor amount. To put it metaphorically, a commitment is like marrying a strategic course of action; an option is dating a strategic alternative. For example, buying land on the beach could be considered purchasing an option to build a hotel there in the future. Building a hotel would represent a commitment for the organization. It is easier to sell the option, the land, than the hotel, because the latter is a much more specialized asset. In this example, construction of the hotel is considered the project underlying the option.
The expected value of a business can be seen as a combination of two elements:
The present value of future flows generated on the investments that have already been made in commitments taken on the past.
The present value of future flows that will be generated by the investments that will be made in the future. This is the value of the company’s investment options.
All of the projects that make up a business have something of these two elements; but for commitments, the value of the first element is greater, and for options, the second has greater value. The company’s total value can be seen as a combination of these two types of projects. Normally, in young companies, the second element-the value of its options-is more predominant, while in more mature companies, the of the former-established commitments-is greater. For every plan of action, the company should evaluate the commitment that it requires and the options or possibilities for investment that it generates.
Commitments
For Ghemawat (1991), “commitment is the tendency of organizations to persist in their alternate courses of action or strategies.” Sull (2003) defines commitments as follows: “a commitment refers to any course of action undertaken in the present that obliges an organization to follow a course of action in the future [...] An action becomes a commitment when the company’s future options are restricted in such a way that it would be too expensive to turn back” (page 84).
Commitments have various phases: announcement, allocation of resources, reinforcement and cancellation. Among the positive characteristics or benefits of the commitments mentioned by Ghemawat and Sull are the following:
They are major investments in durable, specialized and illiquid assets that may be difficult to imitate in other companies. These assets are called “sticky” assets, because they are so hard to unload.
They help to obtain the resources needed for an organization to survive, because they attract investors, employees and clients.
They may dissuade possible competitors from entering the market.
They may induce clients, partners and allies to step in with complementary investments and adopt the standards proposed by the company.
They inculcate a feeling of deliberation and purposefulness in employees, which can help to establish priorities and coordinate actions, and also motivates and inspires them to persevere despite the difficulties.
But commitments also had negative aspects:
They may limit an organizations flexibility. They prevent certain actions or the development of certain abilities.
They obviate the possibility of taking certain courses of action or to pursue certain options the company had open before.o They may lock an organization into obsolete patterns of operation and competition.
Types of commitment
Sull says commitments have a lifecycle, by which they can be classified into three categories:
Initial commitments, when a company begins a business and the first decisions give an identity to the organization, defining what it can and cannot do.
Commitments that reinforce previous commitments. When the business matures, executives reinforce the company’s identity with new commitments.
Obsolete commitments. When a business is in decline, the original identity may be insufficient or counterproductive, and the business must be transformed through new commitments, which may be a complete turnaround from the previous ones.
Factors that increase commitment
According to Ghemawat, there are four main factors that increase commitment to a project or business:
Sunken costs. These arise when a company invests in durable, specialized, non tradable (difficult to buy and sell) or intangible assets; when it is difficult to unload the assets acquired. Some examples of this type of asset are production capacity, customer base, and organizational know-how.
Opportunity costs. These rise as the window of opportunity for investing in a project closes. To estimate the importance of opportunity costs, we can evaluate the possibility of re-acquiring assets that were sold off in the past, the possibility of reassigning resources to other new uses and the possibility of maintaining liquid reserves that enable the company to maintain its flexibility and to move quickly to take advantage of new opportunities.
The time it takes to make changes in the strategies or resources. A company’s ability to change its assets and strategies is restricted by the commitments it has at a given time. It takes more time to modify its fixed assets than its marketing expenses. It may take years to change the company’s assets and strategies. The criteria to evaluate this factor are the cost and time it takes to accumulate the assets, the cost of adjusting them, and the cost of accelerating their accumulation or modifying them.
Organizational momentum due to psychological and sociological reasons. When a company has a strong organizational culture, many decisions are made on a routine basis, or according to general principles, more than a calculation of their costs and benefits. Even in situations in which decisions are based on the rational calculation of costs and benefits, the ones making the decisions have psychological trends and distortions that are difficult to avoid. In contrast, a company that makes all its decisions based on analysis of costs and benefits is considered opportunistic, it is accused of failing to respect its long-term commitments. The criteria used to evaluate this factor are the degree of inactivity or passivity of the organizational culture, the prevailing use of routines and tendency to make decisions based on principles, instead of a rational cost-benefit analysis.
Executives should differentiate their decisions by the degree of commitment they require. The concept of commitment obliges us to think of the future in terms of the momentum and delay of change, the opportunity costs and the sunken costs. The questions we should ask under this approach are:
What are the main commitments acquired by a company: production capacity, the client base or organizational know-how?
What degree of commitment do the new actions that the company wants to carry out represent?
Are there sunken costs involved? Are there durable, specialized, non-tradable (difficult to buy and sell) or intangible assets? Are other major opportunities lost with their acquisition? Has the window of opportunity on these closed?
Would it take a lot of time to change strategies and assets once they are acquired?
Is there a strong organizational culture in favor of established routine, the use of general principles, and little analysis in decision-making? Should this be changed?
Do the strategic leaders have psychological trends that result in a predictable type of decision?
In what phase of evolution are the company’s commitments? Are they initial? Have they been ratified? Are they in the process of change? What commitments should the company make or change in the future? What is needed to do this?
Options
A popular definition of the concept of option defines it as “the right, but not the obligation, to buy (or sell) an asset at some point within a predetermined period of time for a predetermined price” (Copeland and Keenan, 1998). Options can be classified as financial or real. Financial options refer to financial assets that are bought and sold on the securities markets. Real assets are non-financial assets that are bought and sold in their normal markets. Real options can be formal or informal. Formal assets are backed by a written contract that allows the parties, for example, to rescind it in a specified term. Informal options are rights to buy or sell assets on the open markets with no existing contract. These informal options are the most interesting strategically. Let us examine some examples of real options (Copeland and Keenan, 1998):
Growth options, which allow the company to increase the size of its facilities with an additional investment or to extend its investment into another industry where it has advantages from having invested in the first.
Defer and learn options, which allow a company to defer investment until it acquires more information or abilities. For example, if in a given situation there is some uncertainty over the future, but it has cleared up, the company may make the decision to launch a pilot product and, depending on the results (of the learning), launch it on a nationwide basis.
Quit options, which enable the company to reduce the investment or exchange it for more flexible or less costly assets, based on the new information.
Combinations, like multi-stage growth, in which in a sequence of phases, each one depends on the preceding phase. Once a phase is successful, the company moves on to the next. There are times when it must invest in various phases, and at each step there is the possibility of quitting the project, deferring it or spending more to speed it up. By making a combination, another option is generated, additionally to cash flows, which is sequential investment or multi-stage investment. In effect, when the first investment is made, the company gains the right to carry out the second phase.
An analysis of options focuses on the possibility of expanding or shrinking a project according to the results obtained in the market. The characteristics of the project are not assumed to be fixed from the start, but in fact are designed with certain points at which they can be changed. For Luehrman(1998), a business strategy is like a series of related options. Executing a strategy requires making a sequence of important decisions. The strategy establishes the framework in which those decisions will be made, but room should be left to learn from what happens in the business and to act on the basis of this learning. It is said that exercising an option is like investing in the underlying asset, in other words, in the primary project that the option allows for.
Luehrman suggests that investment options be constantly evaluated. Executives must observe the business, cultivate it with investments in maintenance, and seek ways to influence the variables that determine the value of the options that it represents.
Leveraging the value of options
The value of an option can be increased before exercising it, so that it is worth more than the price paid to acquire or created. This is done through value leverage. Turning again to the equivalencies in terminology between financial and real options, we find that the value of an option:
Increases with the value of the underlying asset or project. This is the estimate, provided by the market, of the present value of all the cash flows or intrinsic asset value that the option enables the holder to acquire.
Increases with uncertainty. Uncertainty can be estimated as the standard deviation of possible growth rates in future cash flow generated by the asset. In the options framework, the holder is only exposed to uncertainty on the positive side of the distribution of growth rates; if the result is negative, the holder simply fails to exercise the option.
Declines when the cost of exercising the option (or purchasing the asset) increases. The exercise cost is the present value of the expected cost during the life of the investment opportunity.
Increases with the amount of time remaining to exercise it. This is a period which the investment opportunity is valid; it is the window of investment opportunity.
Increases in parallel to the interest rate on risk-free assets, because the present value of the exercise price declines as interest rates rise.
Is reduced with the cost incurred in keeping the option open.
For Luehrman, active management of a portfolio options involves: a) increasing the ratio of value to cost their projects, in other words, increasing the ratio between the value of the underlying asset to the cost of exercising the option, which can be done, for example, by reducing capital expenditures, increasing prices, cutting costs, etc.; and b) increasing the amount of time available, the volatility of the project (other words, the time the project may be put off) or the variation in its value. Over time, the index of project’s value and volatility declines. Active management of the portfolio of options allows the company to push them in the right direction.
Types of real options
According to Luehrman, strategic options can be categorized according to their investment priority. The recommendations are the following:
Invest now. The business must exercise the option and invest in the underlying asset. The company must commit to investment in the project to create the value. The project is mature.
Maybe now. The business can still wait. It must determine whether it is worth investing in soon, evaluating whether the benefits of waiting are greater than the cost of waiting, which include the loss of market share, the risk that a competitor will take the lead, the risks that regulations will change, the closing of the window opportunity, etc.
Probably later. The business must try to separate the more valuable projects from the less valuable ones.
Probably never. There is little hope that the project will be worth the trouble in the future.
Never invest. The option should be left to expire. The window of opportunity should be allowed to close. The project is considered to have no value for the company.
We must also consider future options that do not yet exist, but which may emerge later on.
Probable options. These are the options that will be created and that will receive attention and resources in the next five years.
Possible options. These are options that may be generated in the next 5 to 10 years.
Options that are impossible in the medium term. These are options that the company is unlikely to devote attention or resources to in the next 10 years.
The questions that can be asked in this framework are the following:
What options does the company have? How are other options created to increase the company’s formal and informal flexibility? Are the options being considered options of growth, reduce or quit, learning, mixed?
How does the value of viable options increase? Can we increase the ratio of the underlying value to the exercise price? Can we expand the window opportunity or the volatility of its value? What investments are required to keep the possibility open of continuing to invest?
What options must we exercise by investing in the underlying asset in the short term? In the medium term? What options should we not exercise? Might there be a buyer interested in them?
What options is it possible to create in the future? What are the options of buying or investing in a project or of selling and divesting of a project? Who would be interested in buying the option to invest or divest? Who would be interested in selling the option to invest or divest?
The strategic action system
The task of analyzing strategic actions can be visualized in two dimensions: the portfolio of actions or the process of generating actions; or the dimension of commitments or options. This results in four primary tasks:
A model for the system of strategic action to integrate some of these ideas incorporates the following elements:
Its causes. These are the factors that determine that the action is carried out. Causes can be classified into: a) the achievement of the performance objectives that results in the planned actions; b) having the resources and competencies to act and to be able to act, which generally results in emergent actions; c) actions imposed by the government or society to maintain a company’s legitimacy; and d) other “prefabricated” actions that do not contribute to the explicit goals of the organization or make use of its available resources and competencies.
Strategic actions. These are actions that change the objectives, domain, competitive advantages, resources and competencies, mode of growth administrative system of the organization. They can be viewed as options or commitments.
Results. These of the consequences of the actions of various organizations within the context of the restrictions of the situation. There the way in which the performance of an individual, business, company, industry and society may vary with the actions carried out. They may also be seen as the effect of the organization’s actions on participating groups, clients, shareholders, employees, vendors, and society at large.
Others’ actions. Competing actions from other organizations may weaken a company’s performance. Cooperating actions by other organizations may improve the company’s performance (Brandenburger and Nalebuff, 1996).
Business climate. This includes restrictions that limit the company’s margin of action, as well as elements in the surrounding climate that favors stimulate certain actions. This includes government, society, and the institutions that frame the organization’s action.
Decision-makers need to analyze three important connections: a) the connection between causes and actions (what causes the actions?), b) the connection between actions and results (what is the mechanism of transmission from action to results?) And c) the connection between results and causes of the action (what importance do results have as a determining factor in the actions?). (Ansoff, 1969). These three questions are important for understanding the system. The unit of analysis is not the organization or any of its parts, but rather the system that constitutes an action. According to this model, an analysis of the actions should focus on studying:
What strategic actions has the company carried out or wants to carry out?
What competing or cooperative actions have other organizations carried out?
Why are those actions carried out? To what extent are the expected results taken into account to determine the actions? Is there an orientation toward results? Who makes the decision to carry out the actions? Are there trends or errors in the perspective of our organization or in competing and cooperating organizations?
What results do these actions produce in individuals, business, company, industry and society? Are the actions aligned to impact all five levels at once? Are their actions taken only to improve the performance of one of these levels? What problems could a lack of alignment cause?
What elements in the environment, and in what way, restrict, stimulate or force organizational actions?
This analysis may be historic, if it encompasses the main actions taken by a company in a certain period, or forward-looking, it examines the main actions that will be taken in the future. We suggest preparing a table with a list of possible strategic actions on the lines, and the type or level of commitment or the options in the columns. The portfolio of the company’s current and future commitments and options indicates it strategy. Areas of action where it has established commitments are as important as areas where it does not plan to act in coming years.
This table describes the projects or actions related to the lines and columns, in order to form an idea of how many actions there are and what are the priorities. We can then evaluate the company’s portfolio actions according to the following categories:
Mature portfolios. Well-defined. Many commitments, few options.
Young portfolios. Very flexible. Few commitments, many options.
Decadent or failed portfolios. Commitments with few options, and which must be modified or canceled.
Incipient portfolios. With just a few options.
The company must invent its future by phases and chart a general panorama of what each phase will contain, in other words, define what its portfolio of actions will be when each phase. Explicitly planning by phases has advantages and disadvantages. The main advantage is that many times, a company can act better in the present phase if it knows what the future phases are, and how these phases articulate with each other. The disadvantage is that because circumstances change, assuming that excessive commitment to certain actions may later bring a sense of failure that discourages the organization. Organizations need to maintain a certain flexibility in order to take advantage of the opportunities that arise and reinvent their future.?
References
Ansoff, H. I. “Toward a strategic theory of the firm”, en Ansoff, H.I. (comp.), Business Strategy, Middlesex: Penguin, 1969.
Bower, J.L. y Gilbert, C.G. From resource allocation to strategy, Nueva York: Oxford, 2005.
Brandenburger, A.M. y Nalebuff, B.J. Co-opetition, Nueva York: Currency Doubleday, 1996.
Copeland y Keenan, “How much is flexibility worth?”, The McKinsey Quarterly, 1998, núm. 2.
Copeland y Keenan, “Making real options real”, The McKinsey Quarterly, 1998 núm. 3.
Courtney, H. 20/20 Foresight: Crafting strategy in an uncertain world, Harvard Business School Press, 2001.
Dixit, A.K. y Pindyck, R.S. “The options approach to capital investment”, Harvard Business Review, mayo-junio de 1995.
Ghemawat, P. Commitment: The dynamic of strategy, Nueva York: The Free Press, 1991.
Kaplan, R.S. y Norton, D.P. The strategy-focused organization: How balanced scorecard companies thrive in the new business environment, Boston: Harvard Business School Press, 2001.
Leslie, K.J. y Michaels, M.P. “The real power of real options”, The McKinsey Quarterly, 1997, núm. 3.
Luehrman, T. “Strategy as a portfolio of real options”, Harvard Business Review, septiembre-octubre de 1998.
Luehrman, T. “Investment opportunities as real options: Getting started on the numbers”, Harvard Business Review, julio-agosto de 1998.
Mintzberg, H. Tracking strategies, Oxford: Oxford University Press, 2007.
Sull, D.N. Revival of the fittest: Why good companies go bad and how great managers remake them, Harvard Business School Press, 2003.
Strategic Action: How to Make Strategic Analysis Relevant
The traditional process of strategy formulation normally begins with an analysis of the external environment; then the characteristics of the organization, then possible courses of action and, finally, how to implement the selected alternatives. Although this process may be logically correct, it means that a lot of the time and resources allocated to the process are used up in the first two phases, leaving the last two as a consequence of the analysis. Perhaps the lack of attention to strategic action is due to a lack of awareness, or the complexity of its concepts. As a result, many observers conclude that the field of strategic management is somewhat removed from organizational ¡ction and a company’s day-to-day activities.
The same argument can be made about execution activities, which up until recently (Kaplan and Norton, 2001) were taken into account only when the first three phases of analysis were complete.
The purpose of this article is to review the basic concepts that have been proposed to evaluate strategic actions, and to propose that these concepts be used more widely so that strategic action is more relevant in the day-to-day life of the organization. This is a simple question of priorities: it is the strategic actions (and their execution) that ultimately affect the organization’s performance. In this text, we propose some guidelines for analyzing strategic actions based on concepts that have been developed in this area, and we recommend that, except in cases where the strategic formulation process is being undertaken for the first time, they be used for an annual strategic review.
The actions taken by an organization can be seen as strategic actions or operating actions. Operating actions are those taken to follow an established procedure within the framework set for the organizational strategy; for example, procurement of raw materials, payrolls, manufacturing a product, or serving customers. Strategic actions are those that modify the administrative system, resources and competencies, competitive advantages, domain, mode of growth or performance objectives. In some companies, the difference between operating and strategic actions is recognized by allocating some resources to an operating budget an others to a strategic budget. This company’s strategic budget can be seen as the money it puts into changing the company; for example, changing its market share or adopting new directions, new markets, new business resources and models.
We find the distinction made by Mintzberg (2007) between intentions and realized action to be useful. These are different, because there are intentions that are never carried out and there are realized strategies that are never premeditated. In other words, there is an ongoing process of learning on the go, which modifies intentions during the realization phase, because internal and external conditions change, sometimes quickly, and over time important elements that were not initially taken into account come to light. We can distinguish, then, between actions that were planned or unplanned, and actions that were carried out, or not:
The concepts in which we can see the application of these ideas are as follows: the portfolio of strategic actions, the phases for formulating strategic actions, the degree of commitment to an action, and real options. At the end, we offer some general recommendations on the way to model a system of strategic action.
The Portfolio of strategic actions
Here we present a classification of strategic actions by their impact on the organization’s performance goals, domain, competitive advantages, resources and competencies, mode of growth, or administrative system.
Performance objectives. In terms of their impact on performance objectives, strategic actions can be divided into those which change the level, growth or trajectory of organizational financial performance, including changes in revenues, costs, profits, returns, risk and values. Changes in the relative weight of current performance with respect to future performance are important. It can also help to have an idea of the degree of leeway or financial flexibility that the organization wishes to maintain given uncertainty in its environment.
Competitive advantage. Strategic actions frequently seek to change the capacities and positioning of the business with respect to its peers, through the following aspects:
Actions taken to change competitive advantages may be made in response to similar actions by competitors, or at the company’s own initiative. In the case of competitive reactions, the company may seek to surpass, equal or reduce the impact of rival actions.
Resources and competencies. These include changes in the efficiency of the utilization or leverage of current resources (physical, financial, technological and human), the development of new resources for potential utilization in the future, and acquisition of new competencies with existing resources or those that may be developed in the future.
Mode of growth. In this category we normally find acquisitions and divestitures, organic development, and joint ventures.
Administrative system. This may include: changes in the organization’s corporate governance (who has the authority and responsibility for making decisions), changes in top management team and its coordination, changes in the chain of command (centralized or decentralized), changes in organizational structure (by functions, geographic areas, product lines, matrix or hybrid); changes in information system and incentives, changes in strategic planning and organizational learning system, changes in corporate values and philosophy, and others.
We recommend preparing an inventory of the portfolio of past, current and intended strategic actions. Some of the questions that arise from this diagnosis are:
Phases of an action’s development
Phases of an action’s development
A similar process can be seen in Bower and Gilbert (2005). We recommend performing a diagnosis of how many strategic actions the company has in each phase of the process, and how many actions go on from phase to phase. Comparing the number of actions in the early phases and in the later phases indicates the company’s degree of strategic maturity. A company with a few actions in the early phases does not innovate much, and its future may be in jeopardy. Some questions that arise from this scheme are the following:
Commitments and options
For our purposes, we can classify strategic actions into two types: commitments and options. Commitments are major investments, difficult to go back on, which attain the desired objective under a certain future scenario. Options are tentative investments but leave the door open for other future investments and that can generally be abandoned. The company may invest in options to hedge the risk that the scenario will be different from what it expects. Commitments are major bets in which much can be won, or much can be lost. Options are minor investments that allow the company to maintain flexibility by building up capacities that may be useful in the future. If the future is as expected, the company can invest more and profit from it; if the future is not as expected, it will only have lost a minor amount. To put it metaphorically, a commitment is like marrying a strategic course of action; an option is dating a strategic alternative. For example, buying land on the beach could be considered purchasing an option to build a hotel there in the future. Building a hotel would represent a commitment for the organization. It is easier to sell the option, the land, than the hotel, because the latter is a much more specialized asset. In this example, construction of the hotel is considered the project underlying the option.
The expected value of a business can be seen as a combination of two elements:
All of the projects that make up a business have something of these two elements; but for commitments, the value of the first element is greater, and for options, the second has greater value. The company’s total value can be seen as a combination of these two types of projects. Normally, in young companies, the second element-the value of its options-is more predominant, while in more mature companies, the of the former-established commitments-is greater. For every plan of action, the company should evaluate the commitment that it requires and the options or possibilities for investment that it generates.
Commitments
For Ghemawat (1991), “commitment is the tendency of organizations to persist in their alternate courses of action or strategies.” Sull (2003) defines commitments as follows: “a commitment refers to any course of action undertaken in the present that obliges an organization to follow a course of action in the future [...] An action becomes a commitment when the company’s future options are restricted in such a way that it would be too expensive to turn back” (page 84).
Commitments have various phases: announcement, allocation of resources, reinforcement and cancellation. Among the positive characteristics or benefits of the commitments mentioned by Ghemawat and Sull are the following:
But commitments also had negative aspects:
Types of commitment
Sull says commitments have a lifecycle, by which they can be classified into three categories:
Factors that increase commitment
According to Ghemawat, there are four main factors that increase commitment to a project or business:
Executives should differentiate their decisions by the degree of commitment they require. The concept of commitment obliges us to think of the future in terms of the momentum and delay of change, the opportunity costs and the sunken costs. The questions we should ask under this approach are:
Options
A popular definition of the concept of option defines it as “the right, but not the obligation, to buy (or sell) an asset at some point within a predetermined period of time for a predetermined price” (Copeland and Keenan, 1998). Options can be classified as financial or real. Financial options refer to financial assets that are bought and sold on the securities markets. Real assets are non-financial assets that are bought and sold in their normal markets. Real options can be formal or informal. Formal assets are backed by a written contract that allows the parties, for example, to rescind it in a specified term. Informal options are rights to buy or sell assets on the open markets with no existing contract. These informal options are the most interesting strategically. Let us examine some examples of real options (Copeland and Keenan, 1998):
An analysis of options focuses on the possibility of expanding or shrinking a project according to the results obtained in the market. The characteristics of the project are not assumed to be fixed from the start, but in fact are designed with certain points at which they can be changed. For Luehrman(1998), a business strategy is like a series of related options. Executing a strategy requires making a sequence of important decisions. The strategy establishes the framework in which those decisions will be made, but room should be left to learn from what happens in the business and to act on the basis of this learning. It is said that exercising an option is like investing in the underlying asset, in other words, in the primary project that the option allows for.
Luehrman suggests that investment options be constantly evaluated. Executives must observe the business, cultivate it with investments in maintenance, and seek ways to influence the variables that determine the value of the options that it represents.
Leveraging the value of options
The value of an option can be increased before exercising it, so that it is worth more than the price paid to acquire or created. This is done through value leverage. Turning again to the equivalencies in terminology between financial and real options, we find that the value of an option:
Increases with the value of the underlying asset or project. This is the estimate, provided by the market, of the present value of all the cash flows or intrinsic asset value that the option enables the holder to acquire.
For Luehrman, active management of a portfolio options involves: a) increasing the ratio of value to cost their projects, in other words, increasing the ratio between the value of the underlying asset to the cost of exercising the option, which can be done, for example, by reducing capital expenditures, increasing prices, cutting costs, etc.; and b) increasing the amount of time available, the volatility of the project (other words, the time the project may be put off) or the variation in its value. Over time, the index of project’s value and volatility declines. Active management of the portfolio of options allows the company to push them in the right direction.
Types of real options
According to Luehrman, strategic options can be categorized according to their investment priority. The recommendations are the following:
We must also consider future options that do not yet exist, but which may emerge later on.
The questions that can be asked in this framework are the following:
The strategic action system
The task of analyzing strategic actions can be visualized in two dimensions: the portfolio of actions or the process of generating actions; or the dimension of commitments or options. This results in four primary tasks:
A model for the system of strategic action to integrate some of these ideas incorporates the following elements:
Decision-makers need to analyze three important connections: a) the connection between causes and actions (what causes the actions?), b) the connection between actions and results (what is the mechanism of transmission from action to results?) And c) the connection between results and causes of the action (what importance do results have as a determining factor in the actions?). (Ansoff, 1969). These three questions are important for understanding the system. The unit of analysis is not the organization or any of its parts, but rather the system that constitutes an action. According to this model, an analysis of the actions should focus on studying:
This analysis may be historic, if it encompasses the main actions taken by a company in a certain period, or forward-looking, it examines the main actions that will be taken in the future. We suggest preparing a table with a list of possible strategic actions on the lines, and the type or level of commitment or the options in the columns. The portfolio of the company’s current and future commitments and options indicates it strategy. Areas of action where it has established commitments are as important as areas where it does not plan to act in coming years.
This table describes the projects or actions related to the lines and columns, in order to form an idea of how many actions there are and what are the priorities. We can then evaluate the company’s portfolio actions according to the following categories:
The company must invent its future by phases and chart a general panorama of what each phase will contain, in other words, define what its portfolio of actions will be when each phase. Explicitly planning by phases has advantages and disadvantages. The main advantage is that many times, a company can act better in the present phase if it knows what the future phases are, and how these phases articulate with each other. The disadvantage is that because circumstances change, assuming that excessive commitment to certain actions may later bring a sense of failure that discourages the organization. Organizations need to maintain a certain flexibility in order to take advantage of the opportunities that arise and reinvent their future.?
References
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