Wednesday, 8 March 2006

Why two strategies are often better than one

Suppose you're playing poker. You look at the cards on the table, and those in your hand. You can't be beaten. So you raise.

Corporate strategy discussions use lots of analogies like that, and they can be helpful. But what they hide is the fact that in the real world, we very rarely have complete information. We don't know what our competitors are doing; we don't know what factors in the world might change. So even if we could come up with an optimal strategy based on what we know, it might be invalidated by facts unknown to us.

The risk mitigant to uncertainty is often diversification. We don't know which stock will go up, so we buy them all, or a lot of them. But in strategic discussions, how often do companies consider having two strategies or three or a dozen?

Clearly it is not efficient to try to do three things when you could do one. But it is not efficient to buy the top three performing stocks: you could have put all your cash in the best one if you knew which one that was going to be.

There is a lovely piece of research about how this relates to executive behaviour. Suppose I give a hundred pounds to ten people to enter a large poker tournament, with a prize for the one who wins the most. It is likely that the winner will be the person who made the biggest bets and was lucky, not the prudent gambler. So if we reward executives solely by the size of their financial successes, we discourage diversification, so when they do get it wrong, they get it very wrong. There have been so many examples of this recently it would be jejune (as well as potentially actionable) to name names.

So by all means have a strategy. But part of that strategy should be what you do when the strategy goes wrong and how you spot that that has happened early enough. One solution might be to put, say, 50% of your resources on your best guess as to the right thing to do next, 30% on another likely possibility and 20% on a rank outsider. At least you'll have the other projects to fall back on it you turn out to be wrong about the best strategy. Think of it as an ecological approach to corporate strategy.

Finally, Maynard Keynes is important here:

When somebody persuades me I am wrong, I change my mind. What do you do?

Strategies have to be monitored regularly and resources reassigned in the light of new evidence. Keeping an open mind about what might work in changing conditions is vital.

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