Which Path Are You Walking? – pt. 113/09/2023
Which Path Are You Walking? – pt. 218/09/2023
How many strategic plans does your company need?
Factors to consider when selecting the unit of analysis for crafting your company’s strategy
In making strategic decisions, organizations, whether corporate entities, investors, or nation-states, must first determine the appropriate level of aggregation for conducting the supporting analyses. While this might sound obvious, many decision-makers fail to do so systematically.
To begin with, it is not unusual to see large corporations attempting to formulate detailed action plans relying on very aggregated analyses. This approach suffers from the issue of “the average of averages” – for instance, merging profit margins from entirely different units into a single figure, assuming uniform productivity across all plants, and so on. As a result, data loses its meaningfulness, insights drawn are biased or outright incorrect, and processes are imposed in contexts where they are simply ineffective. The inability to generate meaningful recommendations based on excessively aggregated data may explain the wave of conglomerate breakups in the 1990s and 2000s: from more than 60 in 1980 to just 24 in 2000. Remember: when you average out Beethoven’s 9th symphony, all you get is a mere buzz.
On the contrary, many companies simply aggregate action plans developed at the most granular unit for which a P&L can be identified and label that as their Strategy. In this approach, synergies are rarely identified, and common tactics are never studied and analyzed. Furthermore, prioritization among initiatives developed by various units is often lacking, as a holistic assessment of all options is rarely undertaken. The outcome is a strategic plan that lacks coherence.
To underscore the importance of this choice, one must recognize that the level of granularity at which an issue is analysed directly impacts the conclusions drawn from the analysis, and at times, can even reverse it.
Take, for example, ESG investing. If you examine the issue at an aggregate level, you may find that some companies can be classified as “brown” (indicating that they pollute a lot) while others as “green” (they generate lower pollution). As an investor aiming to have a positive environmental impact, it might seem sensible to divest from brown companies as a form of punishment and invest in green ones as a form of reward. This approach effectively transfers funds from Energy and Utilities companies to law and accounting firms.
Digging deeper into the analysis, you can scrutinize the impact of specific projects and initiatives. A 2021 paper titled “The ESG – Innovation Disconnect: Evidence from Green Patenting” by Cohen, Gurun, Nguyen underscores that projects and initiatives aimed at reducing carbon emissions are predominantly found within companies operating in the energy and utilities sector and that, currently, generate high levels of pollution. Furthermore, even a modest reduction in carbon emissions from these companies is equivalent to dozens of “green” firms achieving carbon neutrality. Accountants and lawyers just have limited scope for further reducing their carbon emissions.
Adopting a more granular approach would allow some ESG investors to realize that they can achieve a more substantial impact by investing in those companies they are currently shorting if their investment is tied to a specific project. As eloquently put by Kelly Shue, a finance professor at the Yale School of Management, increasing the cost of capital for brown firms actually tends to shift their focus towards short-term objectives, discouraging innovation in greener alternatives.
In corporate environments, just like in nation-states, the nature of the decisions one can make hinges on the level of aggregation of information and data.
In the realm of public administration, the primary data that needs to be gathered and analyzed is the preference of the population on a particular issue. The decision to address a specific matter at the local, regional, or national level directly influences the detected preference for that issue. For instance, let’s examine the number of parking spaces required to efficiently serve a bakery. Picture a region where a large proportion of the population resides in cities well-served by public transportation, but also encompasses a small municipality nestled in a mountainous area, heavily reliant on cars. In this scenario, the small municipality is likely to express a markedly higher preference for parking compared to the broader regional preference.
Decisions should be taken by the individuals who will bear their consequences. Article 10(3) of the Treaty on European Union stipulates that “Decisions shall be taken as openly and as closely as possible to the citizen”. In essence, this implies that decisions should occur at the most localized level, where the majority of the impact is felt, and the external effects are minimal.
Should a nation-state determine the rent to charge a beachfront resort for its plot at the beach? Probably not, as the consequences are predominantly local. The municipality is best positioned to strike a balance between the rent (tax) collected on that plot, the preservation of the beach’s beauty, and the ability to offer tourists a comfortable and convenient experience. However, when it comes to deciding whether to build a high-speed rail connection spanning multiple regions, the answer is likely affirmative, as the repercussions extend to the entire population of the country. Too often nations try to deal with local matters by imposing uniform regulations while granting local administrations or vocal minorities the power to veto decisions when the impact falls largely outside that group.
In a similar vein, when the unit of analysis is a conglomerate, executives should establish widely applicable values, guidelines, and objectives (setting the overarching ambition), while granting leaders at lower levels of the hierarchy ample freedom to determine the “how”.
Embracing the “smallest scale possible” approach can benefit both states and companies for other reasons too. First, in smaller groups, individuals tend to personally know all other members. This fosters accountability and discourages opportunistic behavior since one must live with the consequences of their actions, for instance, the disapproval of their peers. Second, this approach reduces risk. When different units are allowed to test slightly different approaches, it becomes possible to fail and learn. If one approach proves unsuccessful, the damage is contained within that unit, while other units can draw valuable lessons from it. In this way, the sacrifice of one unit ultimately benefits the entire system.
What should executives consider when determining the level of granularity for the analyses that underpin the strategic planning process?
First, the level of granularity should align with the type of decisions that have to be taken at the moment. There are times when executives must set the overarching vision of a diverse conglomerate and should focus on commonalities and differences among the businesses, rather than making decisions solely based on averages. In other cases, leaders need an action plan, which can only be formulated by the individual businesses. In all cases, managers (and consultants) must ensure their decisions align with the level of analysis they choose.
Second, before choosing the level of granularity of the analysis, executives should assess the degree of similarity among the businesses in their company. Three critical aspects warrant consideration:
- Asset Specificity: Do these businesses possess unique, non-interchangeable assets?
- Competency Specificity: Are their core competencies specialized and non-transferable, such as deep technological expertise in a specific field?
- Market Dissimilarity: Do these businesses operate in markets characterized by distinct clients, competitors, and distribution channels?
If the answer to these questions is “yes”, then executives should consider breaking down the unit of analysis into smaller, more homogeneous segments.
Finally, it’s essential to involve a diverse group of managers from all organizational levels in the formulation of the company’s strategy. This ensures that managers have a comprehensive understanding of the hypotheses, analyses, and rationales underpinning the objectives set at higher levels. Such participation enables them to craft specific and innovative tactics within their area of competence, aligning with the firm’s overarching direction while tailoring their approaches to their specific context.
So, how many strategic plans does your company need?
It depends. Our proprietary program and software, Strategy in Action (SiA), guide your company through a systematic and structured process led by expert consultants to answer this question and many others. COTRUGLI Business School is the official distributor of the SiA program in Croatia, Serbia, and Bosnia Herzegovina.
The article is written by Luca Dal Porto, Project Leader and Head of the Italian Market at 3HORIZONS.