Counter strategic risk with pattern thinking.

• Author: Morrison, David J.
• Position: Corporate governance

Because the game of business is becoming more like speed chess, corporate directors who actively instill pattern thinking throughout the management team can help prevent shareholder value from stagnating or collapsing.

COMPANIES FACE different types of risk, and many products have been developed to help hedge or insure against currency, property/casualty, liability, and other risks. A relatively new type of risk -- strategic risk -- is becoming increasingly important for the corporation, yet it must be borne directly by shareholders, management, and the board of directors.

Strategic risk is concerned with one overriding question: Can the firm's business design deliver sustained, above-average growth in shareholder value? This question is equally relevant to established companies, with historically successful business models, as it is to start-ups that are making bets on new ones.

When investors spot strategic risks that threaten a company's health, they react swiftly and decisively -- at times with devastating results. A recent study by Mercer Management Consulting found that 10% of Fortune 1000 companies lost more than one-quarter of their shareholder value in a one-month period at least once between mid-1993 and mid-1998 -- a period generally unmarked by significant market volatility. Nearly 60 of these 100 stock drops resulted not from financial or operational missteps but from poor strategic decisions concerning such things as customer demand or competitive pressure. The tragedy is that these strategic risks can be avoided or managed -- if they are anticipated.

Strategic risk goes to the heart of the board's responsibilities, since the quality of a company's board has become an important evaluation factor for institutional investors. It may be management that sets strategy but it is the board, as Prof. Jay Conger of the University of Southern California points out, that should ensure that a strategy process produces sound choices. Moreover, the board has responsibility for preventing and managing crises -- that is, for risk management.

The typical strategic-planning process is completely unsuited to the task of risk and opportunity identification and strategy-setting. It tends to work incrementally and in parts rather than expansively and holistically. Senior managers too frequently settle for continuous improvement when customers outside of the walls are calling for a revolution. Pattern thinking represents a more effective "early warning system" for strategic risk, more effective in both characterizing risk and in identifying and exploiting new profit opportunities.

Pattern recognition is a fundamental cognitive skill. Genetics, seismology, medicine, and meteorology all harness pattern thinking to understand and predict complex phenomena. Pattern recognition is even central to the games we play: The blackjack player uses them in deciding whether to ask for a card or to hold, the football quarterback to interpret the opponent's defense and evaluate potential plays, and the chess grandmaster to envision possible endgames.

Our research suggests that the same is true of business. Every industry is reshaped by patterns of strategic change that can drastically shift profit and power across the landscape. The ability to anticipate how and why a company's strategic landscape is changing, to connect symptoms to causes, and then to create strategies that lead to significant, sustained value growth is an art and a skill that anyone in business can profitably cultivate.

These patterns can characterize both the ways industries evolve as well as winning business designs that have been proved over and over. To date, we have catalogued more than 30 patterns (see accompanying sidebar), and have organized them along two dimensions: incidence (from traditional to emerging) and type, which expresses the primary areas of the pattern's impact:

* Value Chain patterns describe how industry value chains are compressed, broken, and put together again.

* Customer patterns describe the results of customers' constantly shifting priorities.

* Channel patterns focus on the distribution channel, which is close to critical information on customer preferences and behavior.

* Product patterns show how the value that once existed in the product itself has moved next door, economically speaking, to new scarce assets such as brands, blockbusters, and solutions.

* Knowledge patterns describe how knowledge can be organized and focused to the profit of both supplier and customer.

* Organizational patterns catalogue the innovation in organizational systems in response to the increasing dynamism and complexity of our economy.

* Mega patterns play out across many areas of business over long periods of time.

All of the patterns can be learned, and each has its own implications for the...