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Concepts, Tools And A Collaborative Process For Decision Making In A Complex, Uncertain Environment
Dr. Daniel Owen, Managing Director Strategic Business Processes, Inc.
DanielOwen@StrategicDecisons.net 650-814-9494
Business success begins with the strategic choice of where you are going, not the strategic plan of how to get there.
Our Clients Span A Wide Range Of Firm Sizes And Types, As Well As Industries
Recent Clients
• • • • • • IBM Cadbury Schweppes Attorneys’ Title Insurance Fund Borg-Warner ProLiteracy Worldwide Thrivent Financial for Lutherans • American Safety Insurance • Sandia National Labs • Lawrence Livermore Laboratories Homeland Security Organization • Bridgestone/Firestone • Motts • Hughes Electronics • Delphi • Old Mutual Insurance
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Agenda
• Concepts In Making Risky Decisions
•Tools For Risky Decisions:
•Developing And Describing Strategic Alternatives •Understanding The Sources Of Value •Understanding The Sources Of Risk
•A Collaborative Process For Decision Making
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The Structure Of Nearly All Complex Decisions Includes Alternatives, Uncertainty And Value
Design Alternatives Uncertainty Success New Technology
($10 Million Investment)
Benefit
$ 50 Million
Failure
$ 0
Current Course & Speed
$ 0
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What Information Would You Like To Have Before Making The Decision?
Design Alternatives Uncertainty Success New Technology
($10 Million Investment)
Benefit
$ 50 Million
P
1-P Failure
$ 0
Current Course & Speed
$ 0
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COIN
• What is the probability of calling one flip correctly?
The Thumb Tack Toss Is More Illustrative Of Real Decision Environments Where The Data Is Incomplete
Pin-up
Pin-down
•
Is tack more likely to land pin-up or pin-down?
•
Is coin or tack more like the uncertainties you face in your decisions?
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Sometimes The Value Of A Design Can Be Measured By Its Expected Value
Design Alternatives
New Technology ($10 Million Investment)
Uncertainty
Success P
Market Value
$ 50 Million
1-P Failure
$0
Current Course & Speed
Expected value = p x $50 + (1-p) x $0 = $50p Expected value > Minimum selling price
$0
Once the investment has been made
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The Value Information Prior To Making A Decision Derives From Its Ability To Change What You Would Otherwise Decide
Value of the design with perfect information on Tack Value of the design now
$50 -Min. selling price ________________ $50- Min. selling price
Value-added of perfect information
Value of information depends on: • Whether resolution of the uncertainty could change your design • How certain you are prior to receiving the new information • How risk averse you are • The difference in value among alternative designs • How accurate the new information is
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Summary Of The Concepts In The Thumb Tack Toss
• • There are three components of complex decisions: Alternatives, uncertainty and values Decisions are defined as resource allocations
•
•
We need a quantitative language to deal with uncertainty – probability is that language
Probability represents subjective judgment which depends on experience, analysis and statistical data.
•
•
The value of an uncertain venture depends on the expected value and the decisionmaker’s attitude toward taking risk.
The value of additional information depends on its ability to change what you would otherwise do
•
Good outcomes are what we like. Good decisions are the best we can do.
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Our Approach To Strategic Choice Is Different From Traditional Analyses, Because Of Its Explicit Consideration Of Alternatives And Ranges For Critical Assumptions About The Future
Traditional Analysis
Alternatives • None: Sales pitch for a single solution
Strategic Choice
Alternatives: Alternative #1: Alternative #2: Alternative #3: Major Capital Investment of $400M $50M Investment; less investment, but license new technology Joint venture with Company X
Assumptions: • No new legislation • Variable cost reduction of $475/unit in year 2009 • Sales in year 2009 of 442,000 • --• --Result: Precise Calculation Based on Assumptions
Ranges on Assumptions: • Regulation: No new legislation Extreme in California only US adopts California extreme • Variable Cost Reduction in year 2009: $400/vehicle to $650/vehicle • Sales in year 2009: 410,000 to 475,000 Result: Side-by-Side Comparison of Risk and Return Return $180M $95M $50M Risk (80% range) $210-($20)M $130-$0M $110-$30M
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IRR = 16.79% NPV = $126.54 Million
Alternative #1: Alternative #2: Alternative #3:
Agenda
• Concepts In Making Risky Decisions
•Tools For Risky Decisions:
Developing And Describing Strategic Alternatives •Understanding The Sources Of Value •Understanding The Sources Of Risk
•A Collaborative Process For Decision Making
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A ―Strategy Table‖ Defines The Alternative Strategies In Terms Of The Resources Necessary To Make Them Actionable
Strategy Name
Specific resources or actions required to execute each Strategy Number Level of Frequency Degree Of Entries Differentiation Of Update Of Change
16 2 Years All New
Average Price
$1000 Over Competition $500 Over Competition
Current Course & Speed (CC&S)
100% Unique
14
75% Unique
4 Years
Major
Equal to Competition
12
50% Unique
6 Years
Minor
Zero Overlap
$500 Under Competition
10
25% Unique
8 Years
Ornamental
$1000 Under Competition
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A Broad Range Of Actionable Strategies Can Be Developed, Each Representing A Different Perspective Within The Organization(s)
Strategy Name Current Course & Speed (―Stay the course‖) Objective Maintain the current and planned direction and resource allocations •No coordination across market segments •All decisions are made on a program-byprogram basis Reduce the number of products in each market segment. Focus on improving quality and reducing time-to-market. Conserve capital by lengthening product life cycles. Rationale No changes are required; everyone remains comfortable. Continuous incremental improvement is all that is necessary.
Zero Overlap (―Do fewer things, but do them right)
Our capital expenditures have not been very thoughtful. Rather they have been based on ―entitlements‖. Engineering and manufacturing will do a better job if they have fewer things to do. We must halt ―fights among our divisions on the customer’s front lawn‖, resulting from too many products. Once you lose share it is very difficult to recover it. We can worry about profit later. Our manifest destiny is ―Out-sells Ford‖ Our traditional strength has been moving customers from low-end products to high-end products over their life times. We must not relinquish our low-end position to the Japanese
Sustainable 40% (―Return to Dominance‖) Focus on Low-end (―Beat the Japanese at their own game‖)
Resist competitive pressure on our share by introducing more products with shorter life cycles, reduce price and increase differentiation. Counter competitive pressure in the low end of the market with price reductions and new products. Slow product introductions in the high end and lengthen life cycles. Raise high-end prices to offset profitability losses in the low end
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Agenda
• Concepts In Making Risky Decisions
•Tools For Risky Decisions:
•Developing And Describing Strategic Alternatives Understanding The Sources Of Value •Understanding The Sources Of Risk
•A Collaborative Process For Decision Making
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The Decision Sensitivity Identifies The Sources Of Value In The Initially Identified Alternatives
Strategy Name
Average Price
$1000 Over Competition $500 Over Competition
Specific resources or actions required to execute each Strategy Number Level of Frequency Degree Of Entries Differentiation Of Update Of Change
16 2 Years All New
Current Course & Speed (CC&S)
100% Unique
14
75% Unique
4 Years
Major
Equal to Competition
12
50% Unique
6 Years
Minor
Zero Overlap
$500 Under Competition
10
25% Unique
8 Years
Ornamental
$1000 Under Competition
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5 Change from CC&S 0 ($ Billions) -5
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A New, More Valuable ―Hybrid‖ Strategy Combines The Sources Of Value In The Initially Identified Alternatives
Change from CC&S ($ Billions) Average
5 Price Number Of Entries Level of Differentiation Frequency Of Update Degree Of Change
Sustainable 40%
0 -5 5
Zero Overlap
0
-5 5
Focus on Low End
0 -5 5
“Hybrid”
0 -5
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In More Than 250 Documented Applications, The Increase In Value Associated With The Hybrid Strategy Was 50% To 100% Relative To The Organization’s Current Course & Speed
Portfolio Strategy NPV ($B) -2.9 1.2 -0.9 Capital ($B/yr.) 0.8 -0.1 1.5 Variable Profit ($B/yr.) 0.2 0.4 2.1 Operating Profit -0.8 0.6 -0.2
CC&S Sustainable 40% Zero Overlap Increase Low-End Share Hybrid Solution Profitable Share
Initial Alternatives
11.3
0.8
4.7
4.0
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Think Of The Initial Alternatives As Test Wells . . .
Test Well #1
Test Well #3
Test Well #2
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. . . The ―Hybrid‖ Is A New Solution That Combines The Sources Of Value In The Initially Identified Alternative
Production Well
Test Well #1 Test Well #3
Test Well #2
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Agenda
• Concepts In Making Risky Decisions
•Tools For Risky Decisions:
•Developing And Describing Strategic Alternatives •Understanding The Sources Of Value Understanding The Sources Of Risk
•A Collaborative Process For Decision Making
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An ―Influence Diagram‖ Identifies The Critical Uncertainties That Stand Between What We Can Do (Decisions) And What We Want (Value)
Actual Price less Rebate Total Revenue Quality Government Regulation (Compliance)
Portfolio Strategy for each Market Segment •Average price
Segment Size
Shareholder Value ($/share)
Value
•Number of entries
•Level of differentiation •Frequency of update •Degree of change
Styling Execution Sales Volume
Total Cost
Customer Value ($/vehicle)
Competitive Technology
Total Variable Cost Capital Cost
Engineered Scrap
Total Fixed Cost
KEY
Eng’r’g Expense Decision Uncertainty Influence 22
A ―Tornado Diagram‖ Displays The Contribution Of Each Of The Identified Future Uncertainties To The Total ―Risk‖
Profitability ($ Billions) Uncertainty
-20
-10 0 10 20 30
Variable Cost
Current
World Class
Sales Volume
Low
High
Quality
Current
World Class
Marketing Expense
Current
Efficient
Capital Cost
High
Low
Engineering Expense Current Course & Speed
High
Low
Hybrid
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The Tornado Diagram Answers the Question: What Additional Information Do We Need Before Making The Choice?
Profitability ($ Billions) Uncertainty
-20
-10 0 10 20 30
Variable Cost
Current
World Class
Sales Volume
Low
High
Quality
Current
World Class
Marketing Expense
Capital Cost
A few uncertainties really matter to strategic choice, but most don’t
Current
Efficient
High
Low
Other uncertainties should be managed once the choice is made
Engineering Expense Current Course & Speed
High
Low
Hybrid
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The Influence Diagram Is Comprehensive In Identifying The Uncertainties, And The Tornado Diagram Displays The Contribution Of Each Of Those Uncertainties To The Total ―Risk‖
Influence Diagram
Actual Price less Rebate Total Revenue Quality Segment Size Government Regulation (Compliance)
Tornado Diagram
Uncertainty
-20 - 10
Current
Profitability ($ Billions) 0 10
20
30
Variable Cost
Shareholder Value ($ Net Present Value) Value
World Class
Sales Volume Quality
Low
High
Styling Execution Sales Volume Total Cost Customer Value ($/vehicle)
Current
World Class
Marketing Expense Capital Cost
Current
Higher
Competitive Technology
Variable Cost
Total Variable Cost Total Fixed Cost Capital Cost
High
Low
Engineered Scrap Eng’r’g Expense
Engineering Expense
KEY
Uncertainty Influence
High
Low
Current Course & Speed
Hybrid
Note: The ―bubbles‖ on the Influence diagram appear as bars on the tornado diagram
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Agenda
• Concepts In Making Risky Decisions
•Tools For Risky Decisions:
•Developing And Describing Strategic Alternatives •Understanding The Sources Of Value •Understanding The Sources Of Risk
•A Collaborative Process For Decision Making
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The Challenge In Collaborative Decision Making Is To Combine The Most Valuable Components Of Each Of The Team’s Varied Perspectives Into A New, More Valuable ―Hybrid‖ Solution
―The Best Collective Decisions Are The Product Of Disagreement And Contest, Not Consensus And Compromise.‖ -The Wisdom of Crowds James Surowiecki For many teams, diverse perspectives are a frustration, because each team member believes his or her perspective is correct and the others’ wrong. Instead of a compromise, we help aggregate team members’ correct but incomplete perspectives into enhanced shared understanding. Collaborative methods combine the different perspectives among members of the management team to create an improved ―hybrid‖ strategy based on the sources of value within each of their perspectives.
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Enterprise
Management Provides Insight, Learns And Gains Ownership Through A Series Of Structured Dialogues
Decision Makers
Framing: A problem poorly defined will never be solved. The framing dialogue produces clarity within the management team about the scope of the problem to be solved.
Alternatives: Ideally, the set of alternatives represents the range of opinion and debate across the organization. In this sense, the alternatives dialogue is a conflict-surfacing process.
Decision Team
Analysis: What can we agree that we have learned from the side-by-side examination of the initial alternatives? Connection: Create a new, ―hybrid‖ alternative based on an increased level of shared understanding, which combines the best elements of each of the initial alternatives.
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Numbers Don’t Make Decisions — People Do; The Analytical Results Are The Beginning Of The Management Discussion
Strategy Name
Average Price
$1000 Over Competition $500 Over Competition
Specific actions required to execute each Strategy Number Level of Frequency Of Entries Differentiation Of Update
16 2 Years
Degree Of Change
All New
Current Course & Speed (CC&S)
100% Unique
14
75% Unique
4 Years
Major
Equal to Competition
12
50% Unique
6 Years
Minor
Zero Overlap
$500 Under Competition
10
25% Unique
8 Years
Ornamental
$1000 Under Competition
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Decision Makers
Degree Of Change
Change from CC&S ($ Billions) Average
5 Price
Number Of Entries
Level of Differentiation
Frequency Of Update
Sustainable 40%
0 -5 5
Zero Overlap
0 -5 5
Decisions
Focus on Low End
0 -5 5
“Hybrid”
0 -5
Profitability ($ Billions) Uncertainty
-20 -10 0 10 20 30
Variable Cost
Current
World Class
Sales Volume
Low
High
Quality
Current
World Class
Marketing Expense
Current
Efficient
Capital Cost
High
Low
Engineering Expense Current Course & Speed
High
Low Hybrid
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More Valuable Strategic Choices Result from Leveraging The Insight And Understanding Of The Management Team
“We feel that this new approach helps us make better strategic decisions . . . Almost every executive who participates in the process has at some point a „head slapping‟ realization about where the value is in a given strategy.” Dan McGrath Director, IBM Corporate Strategy “Cadbury Schweppes made great strides in its strategic programme last year due, in no small part, to your thoughtful insights and substantial effort.” Todd Stitzer CEO, Cadbury Schweppes “This approach can be used for the formation of a new business, the analysis of a portfolio, the creation of a new offering and all the related strategic decisions. Its use has made bringing a new offering to the market much more effective and timely, so that we can better respond to our customers.” John McClure CEO, CommSouth “We have used the Dialogue Decision Process in more than one hundred major decisions during the past eight years. . . . Our people have used it to systematically identify courses of action, which on average, the teams believe will generate hundreds of millions of dollars in customer value.” Vincent P. Barabba Meeting of the Minds Harvard Business School Press
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References
1. 2. 3. 4. 5. James Surowiecki, Wisdom of Crowds, New York: Doubleday, 2004. James Surowiecki, ―Smarter Than the CEO,‖ in Wired, Issue 12.06, June 2004, http://www.wired.com/wired/archive/12.06/view.html?pg=2. Vincent P. Barabba, Meeting of the Minds, Boston: Harvard Business School Press, 1995. "IBM's Deep Dive Strategy Process," in Continuous Strategy, Washington, DC: Corporate Strategy Board, 2000; pp. 15-35. Michael W. Kusnic and Daniel Owen, ―The Unifying Vision Process: Value beyond Traditional Decision Analysis in Multiple Decision-Maker Environments‖, Interfaces 22: 6 November-December 1992 (pp.150-166). Daniel Owen and Michael Kusnic, "Collaborative Decision-Making in Adaptive Enterprises," in Adaptive Enterprise, Boston: Harvard Business School Press, 1999; pp. 225-242. Daniel Owen and Michael Kusnic, ―Some Experiences with Improving the Quality of Decisions in Large Organizations with Multiple Decision Makers,‖ presented to ORSA/TIMS, November 2, 1993. Daniel Owen, ―The Use of Influence Diagrams in Structuring Complex Decision Problems,‖ in Applied Decision Analysis, McGraw-Hill, 1984; pp. 212-216. Robert T. Clemens, Making Hard Decisions, New York: Duxbury Press, 1995.
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