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Future Imperfect II: Managing Strategic Risk In the Age of Uncertainty

Part two of our series shows how utility companies can manage, but never eliminate, strategic risk.

Fortnightly Magazine - February 2007

an asset or a capability at a prespecified price. A put option works in the opposite direction, giving the holder the right, but not the obligation, to sell at a prespecified price. Such options are commonly used to trade passively managed assets—financial instruments, such as stocks, and standard commodities, such as wheat and oil. But options thinking also can apply to strategic choice, serving to improve the upside and limit the downside consequences. There is, of course, a price for this—the general prohibition on free lunches applies here—and real options typically require present investment to secure the flexibility needed to defer risk or capture opportunity.

Utilities are not strangers to real-option thinking—consider, for example, the decision to acquire more land than a new power plant will need to provide the flexibility to construct a second one in the future. What is needed now is the inclusion of options thinking in the strategic-planning process. Scenario planning can mesh with and assist an options-based strategy in two ways. First, the scenarios themselves suggest options that would be valuable in the event that the scenario is realized. And second, scenarios offer the virtual wind tunnel, which can be used to estimate the value of the option should that scenario come to pass.

For example, a future in which carbon dioxide venting becomes costly would reward an option to build coal-fired power plants that capture the carbon and sequester it from the environment. A utility could build that capability by investing in technology development projects now—recognizing, of course, the risk that carbon capture and sequestration might never prove practical. In that case, the development of another kind of option, that of constructing nuclear power plants, might be warranted. The point here is not to recommend one option over another, but rather to recommend that the strategic conversation among a utility’s leaders include the value of real options in providing flexibility into an unknowable future.

Marrying Strategy and Culture

Finally, developing a capacity for wise strategic choice and effective response to the unfolding future runs deeper than merely adopting certain management tools. More fundamentally, it concerns the ability of a company to learn from events that are not a part of its historical experience, to distill from the cacophony of signals that clutter the business environment, the few that must command attention. And that is less a matter of tools than of organizational culture—the web of unwritten customs, habits, rewards, and punishments that shape the behavior of any corporation.

In the short term, an inflexible culture might serve a company well by providing a highly focused impedance match with its surrounding business environment. Consider Dell, which achieved strategic surprise when it introduced its novel Dell Direct business model in 1984. The power of the model lay in three realizations: (1) standard processors and a standard operating system would allow consumers to switch easily among PC brands; (2) these standard components could be procured and combined with extraordinary efficiency in a distributed logistics system; and (3) a direct sales model, based on the then-emerging Internet, offered better service