21 August 2009 • 7:00 am

The Hypotheses of Strategy

A running theme in these posts has been that of strategy as a hypothesis. I’ve often asserted that all organizations need to change in response to change in the environment; to realize new opportunity and to defend against threat. I’ve said that the organization that fails to change its value proposition will lose relevance, and ultimately become extinct. Most leaders understand intuitively that their job is not only to only to maximize short term results, but to ensure the long-term viability of the organization. Of course, desperate times may cause some leaders to focus excessively on the short-term at the expense of the long term. Balancing focus between the two is one of the great challenges of organizational leadership.

The normal view of strategy as a hypothesis is oriented to the organization itself; a set of assumptions about what the organization should do, and what will happen as a result. Leaders who are engaged in a strategic change program are properly concerned with monitoring those things that are (nominally) within their control; the actions of the enterprise and its constituent parts. Measurement systems, dashboards, and balanced scorecards convey in effective detail the intent of the strategy (through the selection of measures), and the extent to which the hypothesis is playing out (the actual value of the measures relative to established targets). This is all well and good. But it is a disturbingly short sighted view of strategy.

Classic SWOT analysis teaches us that in order to formulate strategy, an organization must understand its internal Strengths and Weaknesses as well as the Opportunities and Threats in its external environment. Understanding of the external environment tends to be a point in time analysis coincident with the strategic planning cycle. A set of facts or shared beliefs about the external environment are presented and agreed upon by the leadership team, and then the strategy is then formed by narrowing a set of hypotheses about what the enterprise should do. The strategy is formalized, performance measures selected, and the whole package is communicated with stakeholders to influence their behavior in achieving strategic objectives. Of course, this is an idealized model, and many organizations fall short even of this established framework.

The disconnect occurs with strategy execution. While monitoring systems to confirm the internal hypotheses of the organization’s strategy are in force, little if any attention is paid to confirming the hypothesis of change in the external environment. External measurements are focused on the direct impact of the organizations efforts; on customer satisfaction, buying behavior, market share, and the like. But it is rare that anything more than a small fraction of the effort to monitor enterprise strategic performance is devoted to monitoring, testing, and either confirming or refuting the hypotheses of the external environment on which the original strategy was based. And the failure of most organizations to make strategic planning a continual process means that even with an awareness of a flawed external hypothesis, the internal hypotheses are unlikely to be quickly revisited as a result. To be blunt, once companies form their strategy, they become dangerously self-centered and oblivious to their environment.

Such was the case with Iridium, a failed attempt to create a global satellite-based mobile phone service. When first conceived, Iridium’s investors (a consortium led by Motorola) believed in a large market opportunity for phones that would work as well on top of Mt. Everest or in the middle of an ocean as in a metropolitan area. While the company was executing on its technology strategy, the terrestrial-based mobile phone industry was exploding. Phones became small, cheap, disposable, and network coverage expanded dramatically. When Iridium was finally able to complete its first satellite-based call, its phones were big, clunky, and expensive. The service simply couldn’t compete with terrestrial mobile, and billions of dollars of investor value was destroyed. Not only were the firm’s hypotheses about the future market for mobile phones flawed, but there was scant revision of the firm’s strategy as these flawed hypotheses became apparent.

Our earlier examinations of the DVD rental and recorded music industries are also relevant here. In each case, the environment changed faster than the underlying strategy, and disastrous results ensured. It seems to me that the principles and mechanisms for external hypothesis monitoring are far less mature and far less frequently accomplished that internal performance monitoring. And in this deficiency may be a root cause for the failure of so much strategic management.

Does your organization effectively and continuously monitor its environment, or just capture a snapshot periodically. Is your strategic management process prepared to quickly adapt to an emergent failure of an external hypothesis? Please offer your comments.

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