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 / Winter 2012 / Issue 69(originally published by Booz & Company)


Best Business Books 2012: Strategy

Yet for all its strengths, I still have a few quarrels with this book. The recent growth of emerging economies might seem to be the result of pragmatic policies, but it’s worth recalling that Deng’s comment about the color of a cat was meant as a corrective to years of doctrinal Communist ideology, which was itself a reflection of Chinese thinking. Indeed, Confucianism is often connected with ideas such as obedience, hierarchy, duty, and filial piety, hardly what we associate with pragmatism. Current successes notwithstanding, it is questionable whether China’s emphasis on central initiatives, like its succession of five-year plans, is better understood as a reflection of pragmatism or as evidence of a traditional Chinese emphasis on hierarchical direction. Further, almost any example of success can be described as the result of pragmatism. Terms like core vision and balance and adaptability are easy to infer ex post when companies are successful, but are conspicuously absent when companies fail.

These concerns notwithstanding, Pragmatic Strategy remains a fascinating book that spurs us to think about strategy in its broader philosophical context, and advances important hypotheses about the values and ideas behind the growing success of companies with roots in Confucian thinking.

Option Games

An equally scholarly book, but one that addresses a very different aspect of strategy, is Competitive Strategy: Options and Games, by Benoit Chevalier-Roignant, a researcher at University of Texas at Dallas, and Lenos Trigeorgis of the University of Cyprus, one of the leaders in the field of real options. For readers interested in the theoretical underpinnings of competition and strategic choice, it’s an important contribution to the field as well as an engaging book.

The authors explore two theoretical traditions — game theory, which comes from economics, and real options, which traces its roots to finance — and show how their insights can inform many kinds of strategic decisions. Game theory, of course, has long contributed to our understanding of moves and countermoves in competitive situations. More illuminating for many readers will be the treatment of real options, which is a more recent theoretical development, but can help managers think in terms of the sequence of decisions they make over time.

Many kinds of options, such as puts and calls in the stock market, can be traded in financial markets, but the distinguishing feature of real options is that they cannot be traded. Instead, they are opportunities that accrue only to the owner of an asset, and include decisions such as whether to expand an existing plant or close it and build a new one. Whereas traditional analysis of decisions like these has employed calculations made at a fixed point in time (such as net present value and discounted cash flow), the contribution of real options is to introduce a temporal dimension and show how strategists can respond flexibly as circumstances change.

Most compelling, as well as original, is an integrative approach to strategy that combines the two approaches, which Chevalier-Roignant and Trigeorgis call “option games.” Real options help illuminate the decision to invest or expand, and the addition of game theory adds the competitive dimension, as each player’s moves take into account the actions of rivals.

Competitive Strategy is replete with mathematical formulas and discussions of theory that can be daunting, but the authors do several things that make the book a worthy read for all strategists. First, they offer many examples from the business press to ground the book in real-world decisions. They illustrate the problem of how best to expand capacity, for instance, by citing Virgin Atlantic’s choice in 2004 to double its fleet with the purchase of 13 Airbus 340s, large four-engine aircrafts, in an effort to match rival British Airways in scope, and Air Canada’s choice in 2005 to purchase the Boeing 787 Dreamliner for its superior fuel efficiency on long-haul flights. The decisions the companies made were very different: Virgin preferred a large, lump-sum capacity expansion; Air Canada followed an incremental and flexible approach. But both can be understood by the combined power of game theory, which considers competitive forces, and the insights of real options, which examine sequences of decisions over time.

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