Better Decisions in uncertain times

Companies can’t predict the future, but they can build
organizations that will survive and flourish under just about
any possible future.

Focusing on pivotal roles
A ship has a captain with a single mind. The “captain” of a large, complex modern
corporation is likely to be dozens, if not hundreds, of people. Aligning those pivotal leaders
so that they can steer the company in response to changing conditions is a major challenge
for most organizations.
An essential first step is simply to define who occupies the pivotal roles. Some companies
may have just a few; others 20, 150, or even more. On the one hand, the smaller the
number, the easier it is to have the intensity of interaction needed to make critical
decisions effectively and collaboratively. On the other hand, the number must be large
enough so that the people involved in decision making can collectively access the full
spectrum of knowledge embedded in a company’s people and its relationships with
other organizations. You’ll never get perfect coverage, but if you wind up saying with any
frequency, “We’re flying blind on this topic without perspective from X,” it’s a good bet that
you’ve kept the group too small.
Since determining what to do under uncertainty usually requires careful debate among
many people across the entire company, you need processes and protocols to determine
how issues are raised, how deliberation is conducted, and how decisions are made. You
also need to clearly lay out the obligations of managers, once the debate and decision
making is over, to put their full weight behind making the resulting actions successful.
I wish there were one-size-fits-all protocols for getting the smart, talented people who
occupy pivotal roles (and who are accustomed to making decisions through a hierarchy) to
work effectively with colleagues in collectively steering the ship. But the hard truth is that
what works in one organization and among one set of individuals may not work in others.
Since the move toward more dynamic management changes power relationships and
the prerogatives of senior executives, a company’s organizational, cultural, and political
norms have a major influence on the ease of transition. (The more hierarchical and less
collaborative the organization, for example, the bigger the challenge.) The best I can do
is to suggest a few general approaches—whose implementation often looks quite different
in different types of organizations—for helping the individuals occupying pivotal roles to
work together in new ways.
Learning by doing
If you require managers to use decision-making-under-uncertainty techniques (such as
scenario planning, decision trees, and stage gating) to make actual decisions, they will
quickly learn how to think differently about the future. And if you have them apply these
tools in teams involving executives from diverse corners of the organization, they will
gain a greater appreciation for the power of collective insight in volatile times, when
information, almost by definition, is fragmentary and fast moving.

Workshop-based adult-learning techniques
Executives can develop new mind-sets and skills, particularly to improve their ability to
manage through the ambiguity and complexity inherent in today’s environment. Some
companies have made progress by developing case studies based upon potential decisions
they will shortly be facing and then using facilitators and friendly colleagues to get
leaders used to surfacing and debating alternative courses of action. Others have found
war gaming useful for illustrating the cost of basing decisions on seemingly reasonable
assumptions when events are moving quickly.
Performance measurement
Companies need to hold their managers not just individually but also mutually
accountable for their actions. This means evaluating how effectively executives contribute
to the success of others. For example, how effective are executives at identifying the
company’s critical issues, even when such issues fall outside their areas of responsibility?
And how proactively do executives provide their colleagues with intelligence, knowledge,
and advice? Peer-assessment techniques often are invaluable in measuring collaborative
behavior.
Just-in-time decision making
Much of the art of decision making under uncertainty is getting the timing right. If you
delay too much, opportunity costs may rise, investment costs may escalate, and losses
can accumulate. However, making critical decisions too early can lead to bad choices or
excessive risks. And making hasty decisions under time pressure or economic duress
allows little room to undertake detailed staff work or to engage in careful debate. Here are
a few suggestions for companies trying to create competitive advantage from their ability
to manage the passage of time decisively.
Surfacing critical issues
Most companies are accustomed to identifying major internal issues, such as whether
to build a business, divest an asset, or lay off people. What’s harder—and has become
increasingly important over the past year or so—is the early surfacing of opportunities
and threats arising out of external events such as dramatic shifts in demand, competitive
behavior, industry structure, regulation, or the macroeconomic environment.
A commonsense approach to identifying such issues early is to poll, regularly, all of the
company’s top managers to get them to identify critical issues they see emerging. Each
manager should provide a rationale for why any issues raised are critical. A small team
of senior executives should review all such issues, designating some as critical and
highlighting others for continued tracking. As time passes, some of these other issues may
become critical; others may become less relevant and disappear from the list.

One challenge: many managers are reluctant to surface emerging issues early, because
they fear being perceived as someone who is weak, or who cries wolf. A well-designed
performance-management system, though, can ensure that the personal risk of surfacing
critical issues late is much greater than the risk of raising them too early.
Performing the necessary staff work
If a critical issue is surfaced early, there is usually time enough to use proven problemsolving
approaches to making decisions under uncertainty. Decision trees, for example,
help managers think about the structuring and sequencing of their decisions. Probabilistic
modeling is useful for understanding the economic consequences of potential outcomes.
Breaking big decisions into smaller, well-sequenced ones (the goal of stage-gate investing)
helps organizations move forward without taking excessive risks. And building scenarios
helps you gain perspective on your critical issues. If a particular decision produces
favorable outcomes under all scenarios, it becomes a “no regrets” move justifying
bold action. On the other hand, if a particular scenario is improbable, but the negative
consequence (if it happens) is large, you need to build contingency plans.
If companies tried to make all or even most of their important decisions in this way, the
costs could be prohibitive, and there wouldn’t be enough management bandwidth available
to do anything but debate issues. Employing a materiality test, such as whether 1 or 2
percent of a company’s future earnings are at stake, is therefore vital. In a typical large
company, this may mean no more than two or three dozen such issues in any given year.
Changing how decisions are made
Few companies are organized to get just-in-time managerial alignment for even a few
issues a year, let alone two or three dozen. Gaining alignment among pivotal decision
makers requires them to spend time together (in person, by phone, or in videoconferences)
to surface emerging issues, share information, debate issues, and make timely decisions.
How much time is needed for such meetings will, of course, vary with the company and its
circumstances but is likely to be in the range of two to three days a month.
The only way to make this happen is to redesign the corporate calendar, along with
corporate processes and protocols for how the meetings are conducted (including their
length, decision-making roles, and required attendees). The redesign should encompass
the creation of processes that enable the rapid surfacing and formal designation of issues
considered critical. In addition, some companies have found it helpful to create a situation
room—a physical place manned by support staff and connected electronically to people
who can’t be physically present—to serve as a hub to mobilize the information needed to
enable debate to take place in real time among the appropriate decision makers.

Rethinking corporate budgeting processes
Everything I’ve been describing flies in the face of management practices that have proven
invaluable at many companies for nearly a century. However, fixed annual planning and
budget processes are antithetical to timely strategy setting and decision making.
Yet it’s important to recall why we have them: they enable the efficient delegation of
authority between managers and subordinates. In return for the freedom to make
decisions and allocate resources, the subordinate contracts through the budget to deliver
expected results. The managers of a large company make tens of thousands of operating
decisions every day, and if all of them required constant deliberations up and down the
chain of command and across the organization, it would grind to a halt.
Jettisoning budgeting, therefore, is hardly an option—though it may have seemed
reasonable at points over the past year, since most of the budgets produced in late 2008 for
2009 proved worthless (as did most companies’ earnings guidance to stock analysts). What
this underscores is a basic problem with budgets: if developments in the marketplace are
sufficiently different from the assumptions used in budgeting, managers can’t make their
numbers no matter what they do. At best, by the time these developments have surfaced to
the top, most of the lead time needed to address the emerging issues has been exhausted.
At worst, the company faces a crisis after being weakened by the hidden costs of all of
the short-term actions (such as maintenance cutbacks for manufacturers or excessive
risk taking for financial institutions) undertaken by managers endeavoring to make their
numbers.
So what’s the answer? Many better-run companies have already adapted the budgeting
process to make it more flexible. A large number use a base case, an optimistic case, and a
pessimistic case to allow for a range of outcomes. More important, a significant percentage
of companies now use rolling budgets to keep their plans current. These approaches aren’t
foolproof—many companies fall into the trap of using too narrow a range (such as plus
or minus 5 percent), and even companies that use rolling budgets usually do so only by
making small incremental adjustments, quarter to quarter, to the base case. Nonetheless,
in a relatively stable environment, these approaches are a significant step forward.
But even rolling budgeting may not be enough to prepare you for a macroenvironment
where you are unsure whether you will be seeing, over the next couple of years, a rapid
return to global growth, an extended period of anemic growth, or a double-dip recession.
One alternative: move to a semiannual budgeting and financial-planning cycle where you
make budget “contracts” for a 6-month, rather than annual, time period and undertake
robust, scenario-based financial-contingency planning for the period from 6 to 24 months
in the future. That approach allows companies both to continue using budgets that hold
people accountable for the immediate future and to shift toward contingency budgets at
the end of 6 months should the circumstances warrant a change of direction. I believe
many companies will find that a semiannual budgeting process works better than either an
annual approach, which is based upon an unrealistic year-long budget-contracting horizon,
or a quarterly update, which requires almost continuous rebudgeting.
Another valuable and potentially complementary approach is to have even 6-month
budgets and the results reported against them automatically adjusted for “uncontrollables.”
That is, to improve accountability you can restate both budgets and results after the fact
to remove, automatically, variances caused by macroeconomic uncontrollables such as
interest rates, commodity prices, and currency movements. This approach can help senior
leaders eliminate uncontrollable losses and windfall gains, thereby holding managers
accountable for their performance in the marketplace rather than for whether the
macroeconomy makes them lucky or unlucky.
Finally, many if not most companies will also find that they need to carve out discretionary
budgets and staff to support just-in-time decision making. These budgets should be
sufficient not just to support the needed staff work but also to provide the resources
needed to begin implementing the decisions until they (and their financial implications)
can be formally built into budgets.
Companies can’t control the weather, but they can design and build a ship, and equip it
with a leadership team, that can navigate the ocean under all weather conditions. Organizations
that become more flexible and skillful at making critical decisions when the
timing is right have enormous opportunities to capture markets and profits from companies
that persist in managing as if the future business environment is reasonably predictable.