Four levels of uncertainty

Citation

Millett, S.M. (2002), "Four levels of uncertainty", Strategy & Leadership, Vol. 30 No. 2. https://doi.org/10.1108/sl.2002.26130bae.001

Four levels of uncertainty

Four levels of uncertainty

Stephen M. Millett

20/20 Foresight. Crafting Strategy in an Uncertain World

Hugh CourtneyHarvard Business School PressBoston, MA2001209 pp.

The arrival of this valuable book on preparing strategies for the future is fortuitous. The terrorist attacks on the USA of 11 September 2001, and the subsequent economic, diplomatic, and military consequences have sent shock waves of uncertainty through the world. The war and the recession present new challenges for corporations to recognize and to manage the enormous risks of the future. While this book, or any book, cannot answer all questions, 20/20 Foresight makes a valuable contribution to the evolution of foreward-looking strategic thinking of business managers.

Hugh Courtney is an associate principal with McKinsey Inc. Drawing upon the experiences of this famous management consulting firm, the author argues that business managers cannot dismiss the future simply because they do not know what will happen. Managers must recognize uncertainty, understand it, and formulate business strategies that explicitly address it.

The author provides a useful nomenclature for the different types of uncertainty, or what he calls "residual uncertainty" – that element of uncertainty inherent to future environments beyond the risks of business analysis. To dismiss the future as unknowable and unpredictable is glib, and to assume more certainty than really exists is irresponsible. We live in a world of different levels of uncertainty – some things are constant and very predictable, while other events are so unimaginable to be both unpredictable and unthinkable, such as hijacked airliners crashing into both towers of the World Trade Center and the Pentagon within minutes of each other!

This book starts with a very simple but powerful idea: if you want to make better strategy choices under uncertainty, then you have to understand the uncertainty you are facing ... you must embrace uncertainty, explore it, slice it, dice it, get to know it.

Courtney identifies four types of uncertainty with the less than eloquent titles of Level 1, Level 2, Level 3, and Level 4. The first is the near-term and the predictable future, while Level 4 is the highly uncertain. In between, Level 2 exists when there are identifiable options (a closed set of possible outcomes) and Level 3 when there are a range of possible outcomes between two expected extremes. Simply recognizing these different types of uncertainty helps managers deal better with risks in the future.

Courtney correctly observes that no single analytical tool will adequately address all business issues across the four levels of uncertainty. This is a conclusion that Battelle reached a decade ago in A Manager's Guide to Technology Forecasting and Strategy Analysis Methods – yet the point is so important it bears repeating for all kinds of forecasting topics. Trend projections, statistical forecasting, and econometrics work very well for level 1 uncertainty, where the number of variables is limited and the coefficients remain constant. But these tools are not appropriate for the other levels. Likewise scenario analysis has applications for levels 2 and 3, and maybe level 4, but not level 1. Once scenarios are prepared, microscopic tools are needed for answers to microscopic questions.

I was surprised to see that McKinsey apparently has adopted probability analysis for at least level 2 scenarios. This has been the practice at Battelle for over 20 years, although the assigning of probabilities to scenarios is still highly disputed and rejected by the intuitive scenario practitioners with the Shell/SRI pedigree. Much of the dispute centers on the confusion between judgmental (Bayesian) and statistical probabilities.

The best part of 20/20 Foresight is the discussion of real options analysis, the most important strategy analysis tool to emerge in the last ten years. It has revolutionized the financing of R&D and investments in emerging technologies. Managers increasingly are embracing the concept of options analysis from the field of financial investment to estimate the current and potential value of new technologies. Those who are not already familiar with this approach will find the explanation in Courtney's book to be very insightful (even foresightful).

In addition to explaining the four levels of uncertainty about the future, the book contains discussions of five basic strategy issues facing managers: shape or adapt, now or later, focus or diversify, old or new tools and frameworks for analysis, and old or new strategic planning and decision-making processes. Oddly, the discussion is rather brief considering that strategy analysis and decision-making are the forte of McKinsey. One gets the feeling that a lot of insights and consulting expertise was not included in the book. While the book does relate some of the levels of uncertainty and tools to each of the five basic strategy issues, a comprehensive matrix (the management consultant's favorite analysis method) is missing.

I hope that Courtney or others will follow up 20/20 Foresight with more details on how and when to use the tools identified in the current book. The treatment of real options analysis was excellent, but the treatment of scenario analysis could be better. There was only a brief mention of game playing and simulations, which are now emerging as potentially powerful tools for strategy-making.

Finally, Courtney's work should be read in the context of business strategy making; in point of view, it is internal looking out to the external. Another, but very different approach, is the external looking back to the internal that Battelle calls "Futuring." The first, well explained by Courtney, starts with the perspective of the company and asks how the company should deal with the uncertainties of the future in the external economic or business environment. "Futuring" starts with the perspective of the changing external environment and asks how it is most likely to affect a company's strategy. Theoretically, it should make little or no difference which perspective you begin with because you have to take both approaches and both should lead to the same conclusions. In practice, however, where you start does indeed bias your conclusions.

Courtney's 20/20 Foresight is the rare book that is both timely and profound. I highly recommend it.