The Magic Formula Of Uncertainty
Five connected underlying structures, leading to uncertainty
In times of great uncertainty, many organizations drop their long-time strategy and discipline, freeze their investments, and wait for a return to normal.
That’s ineffective because it focuses on the what’s happening, and not what’s causing it to happen. Too often, in too many organizations, strategic planning and execution, a discipline with many governance rules and frameworks, does not have an answer to address uncertainty? That clearly has to change, but what can we do about it?
Uncertainty is driven by four primary things, business complexity, proximity, fragility, and time-to-money. These are the factors that have the most critical implications on business success, and these factors are part of the five hidden underlying structures (uncertainty itself is the fifth).
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Amid this uncertainty crisis, merely trying to manage using the “above the water” (what’s readily visible) investment model consisting of maximizing objectives, meeting costs, and optimizing resource capacity, is unlikely to reduce uncertainty. Instead, companies need to change some of the underlying structures, that’s what can help them reduce the uncertainty, bringing it to a level that organizations can live with.
At it’s most simple, uncertainty refers to situations involving imperfect or unknown information – in an organization that uncertainty most commonly applies to demand and production capacity. Production uncertainty is about cost and duration uncertainty. Demand uncertainty is related to the customer, market place and competition – will they buy it, how much will they pay for it, etc.
The more simple cases are the ones involving only production uncertainty. The more difficult cases are those that have both production and demand uncertainties.
All critical investment factors have an impact on uncertainty. No matter where an organization starts, it will inevitably end up in uncertainty. For example, you can reach uncertainty directly from proximity or through a proximity-business complexity-uncertainty path.
Uncertainty can be reached in many ways:
- 4 direct paths starting at Business complexity, proximity, fragility and time
- 7 indirect paths:
- Business complexity → Time → uncertainty
- Business complexity → Proximity → uncertainty
- Business complexity → Fragility → uncertainty
- Business complexity → Time → uncertainty
- Proximity → Time → uncertainty
- Proximity → Business complexity → uncertainty
- Proximity → Fragility → uncertainty
Some definitions will help:
- Proximity factor answers the question: How different is the “to be” (future state) model from the “current” model. This is about having strategies and goals that are either too close, or too far away, from the current model.
- Business complexity is determined by the number components involved in an investment, and the relationships between components.
- Fragility is related to assumptions and considers how resilient those assumptions are.
- Time is simply the time from conception and ideation to realized benefits.
With so much uncertainty, it can be tempting to ignore investment management theory, and if an organization is ony considering the “above the water” aspects of an investment model, focused on objectives and constraints, that may be appropriate. Such an approach does not provide effective ways to include uncertainty in the discussion.
However, the five underlying structures theory goes further, helping to explain what is happening, and why, allowing organizationsto model alternative courses of action and driving better decisions. They help to answer questions around how uncertainty is created, what level of uncertainty is acceptable to organizations, and whether strategies should focus on defensive protections or aggressive moves to try to take advantage of the uncertainty. Then they help guide the right investments and decisions.
Organizations that take advantage of these underlying structures are able to drive improved performance. That shouldn’t be surprising, uncertainty has always been part of long-term value creation. And while smaller, safer investment decisions is a lower risk approach, it also results in lower returns. It effectively commits to traveling one or more of the paths of the uncertainty model in reverse – sommitting the organization to smaller ambitions and goals.
That may be appropriate at times, the decisions are never easy. If you fly too low, you end up in the water. If you fly too high, you will be burned by the sun. This is the Icarus story. Icarus’ father constructed wings from feathers, threads from blankets, clothes, and beeswax. They intended to use the wings to escape from their captivity. The father warned Icarus not to fly too low, for fear of dampness nor too high, for fear that the sun’s heat would melt the wings.
In times of increasing uncertainty, continuing with business as usual is not a winning strategy. To join the ranks of the truly resilient winners, now is the time to choose an investment strategy leveraging the uncertainty factors and find the right altitude.