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 / Summer 2012 / Issue 67(originally published by Booz & Company)


Three Games of Strategic Thinking

All of those graduates learn about Michael Porter’s famous “Five Forces” model of business strategy and receive training in the quantitative methods of decision analysis and discounted cash flows. In short, they learn how to play the first urn game: Understand the industry context, measure the uncertainty, and pick markets with the structural characteristics likely to yield a positive return on the investment.

A prototypical example of a company under this model was the International Telephone and Telegraph Corporation (ITT) under the leadership of the hard-charging Harold Geneen from 1960 to 1977. Geneen transformed the midsized maker of telephony equipment and services with sales of $760 million into a global conglomerate with $17 billion in sales, operating in dozens of countries. Unconstrained by a core mission, Geneen gobbled up more than 350 companies in industries that included auto parts, cosmetics, hotels, insurance, and semiconductors. Trained as an accountant, Geneen famously traveled the world with multiple briefcases stuffed with financial reports, meeting with his business unit managers. He gave them wide leeway in making strategic decisions, but held them to tightly controlled financial measures. According to Bruce Wasserstein’s profile of Geneen in Big Deal: The Battle for Control of America’s Leading Corporations (Warner Books, 1998), “In Geneen’s mind, facts were incontrovertible, an expression of ‘final and reliable reality.’… Once ‘true facts’ were uncovered, management decisions became easy.”

If your formal business education occurred in the 1980s or earlier, this may be the only strategy model you have explored. But if you’ve been in business in the decades since, the other two paradigms will undoubtedly resonate with your own experience more closely, even if you did not receive formal training in them.

Organizational Learning

University of Chicago economics professor Frank Knight challenged the logic of classic urn problems in 1921. Knight pointed out that the notion of risk as addressed by the science of probability and statistics was “radically distinct” from the idea of true uncertainty. Knight used the term risk to describe a situation in which the underlying probability is known, as in the first urn above. Traditional statistical tools offer useful insight into the range of possible outcomes from repeating an event — such as drawing a single ball — given a known distribution. However, what has become known as Knightian uncertainty in academia captures the risk of an uncertain distribution, as in the second urn option.

Building upon Knight’s insight, and drawing upon his own doctoral dissertation in economics at Harvard, Daniel Ellsberg popularized the notion of ambiguity avoidance in the early 1960s. (Ellsberg, a Rand Corporation consultant to the Department of Defense, may be best known outside academic circles as the vocal critic of the Vietnam War who leaked the Pentagon Papers to the New York Times in 1971.) Ellsberg identified a paradox in human behavior in a series of urn experiments. He offered up the option of betting on an urn with a known 50/50 mix of red and black balls versus one with an unknown mix. Most people are indifferent about choosing between red and black in either case. But if asked whether they would rather bet on red from the known mix or on red from the unknown mix (or on black from the known versus the unknown), the majority chose to bet on the second urn — implying a belief that the mix in the second urn was not 50/50. Ellsberg found that when given more complicated choices, people behave in ways inconsistent with this belief. Based on his analysis of this behavior, he postulated that most people make choices that appear logically inconsistent because they prefer to avoid ambiguity — a finding known as the Ellsberg Paradox.

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