In competitive power markets based on locational marginal pricing (LMP), the facts sometimes conflict with popular belief. Most notably: 1. When there’s congestion, the books don’t balance, and...
Future Imperfect: Managing Strategic Risk In an Age of Uncertainty
Part 1 of a 2-part article explores new technologies most likely to influence competitive success.
When fighter pilots list the advantages of one combat aircraft over another, they do not speak primarily of speed. Rather, they refer to the ability of one aircraft to “turn inside” another, to negate other aspects of performance with a superior turning radius. (Figure 1 shows the contrails of the newer F-16 turning inside the vintage F-4.)
For the utility industry, fundamental changes in technology, markets, or regulatory requirements can “turn inside” the ability of companies to respond, as long-lived investments and choice of fuels lock them into their strategic choices for decades. In the meantime, such changes can expose shareholders and customers alike to unnecessary strategic risk if they are left unattended. This article proposes ways for utility leaders to understand strategic risk better and manage it more effectively. 1
Part 1 of this article sets out the problem—the essence of strategic risk, its consequences for the unprepared, and the implications for utility companies. Part 2 will show how utility companies can manage, but never eliminate, strategic risk by using real options analysis and scenario planning, and by building a culture of open inquiry.
Though we tend to think of risk as the monster under the bed, it often appears in the most pleasant of disguises—success. One story—told from the perspective of the victim, Western Union— illustrates how a powerful and successful market incumbent can succumb to risks that spring from a flawed strategic logic. On Jan. 27, 2006, Western Union sent its last telegram, and the company whose name had become synonymous with telegraphy left the business—though in truth, there remained very little business for it to leave. This exit marked the end of a protracted decline that began with a strategic decision to focus on the core telegraph undistracted by any capabilities in telephony.
It was 1879 when Western Union sold its formidable telephone business to a small, start-up company built around the inventions of Alexander Graham Bell, gaining in exchange royalties and a non-compete agreement from Bell. Historian George David Smith notes how this choice focused Western Union’s strategy on its highly profitable core, telegraphy, and on the market for long-distance, business-related communications. 2 To serve this market, Western Union’s leadership fixed upon the notion that wire communication was not about interactive conversations, especially social conversations among individuals, but rather about bursts of terse data—analogous to e-mail. Further, they had become convinced that telephone technology could never improve to offer voice-grade conversations over long distances. Thus, the company concentrated on delivering its standard product to its best customers—and chose exactly the wrong thing to do. No amount of focus in execution could redeem this flawed logic.
The Western Union experience speaks to the enduring power of technology to inflict strategic surprise. We see this power today in the contemporary telephone. Today the incumbent