STRATEGY UNDER UNCERTAINTY
as they began developing strategies for entering local telephone markets. Legislation that would fundamentally deregulate the industry was pending in Congress, and the broad form that new regulations would take was fairly clear to most industry observers. But whether the legislation was going to pass and how quickly it would be implemented if it did were still uncertain. No amount of analysis would allow the long-distance carriers to predict those outcomes, and the correct course of action—for example, the timing of investments in network infrastructure—depended on which one materialized.
In another common level two situation, the value of a strategy depends mainly on competitors’ strategies, which cannot yet be observed or predicted. For example, in oligopoly markets, such as those for pulp and paper, chemicals, and basic raw materials, the primary uncertainty is often competitors’ plans for expanding capacity. Economies of scale often dictate that any plant built would be quite large and would be likely to have a significant impact on industry prices and profitability. Therefore, any one company’s decision to build a plant is often contingent on competitors’ decisions. This is a classic level two situa- tion: the possible outcomes are discrete and clear, and it is difficult to predict which will occur. The best strategy depends on which one does. In classic level two situations, the possible outcomes are discrete and clear but hard to predict
Here, managers must develop a set of discrete scenarios based on their understanding of how the key residual uncertainties might play out. Each scenario may require a different valuation model. Getting information that helps establish the relative probabilities of the alternative outcomes should be a high priority. After establishing an appropriate valuation model for— and determining the probability of—each possible outcome, the risks and returns of alternative strategies can be evaluated with a classic decision analysis framework. Particular attention should be paid to the likely paths the industry might take to reach the alternative futures, so that the company can determine which possible trigger points to monitor closely.
Level three: A range of futures
A range of potential futures can be identified at level three. A limited number of key variables define that range, but the actual outcome may lie anywhere within it. There are no natural discrete scenarios. As in level two, some, and possibly all, elements of the strategy would change if the outcome were predictable.
Companies in emerging industries or entering new geographic markets often face level three uncertainty. Consider a European consumer goods company