Strategic Decision Making

Strategic decision making in uncertain times
A McKinsey Quarterly Reader

mckinseyquarterly.com
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Strategy in a structural break
Richard P. Rumelt
December 2008
During hard times, a structural break in the economy
is an opportunity in disguise. To surviveand,
eventually, to fourishcompanies must learn to
exploit it.
Dynamic management:
Better decisions in uncertain times
Lowell Bryan
December 2009
Companies cant predict the future, but they can
build organizations that will survive and fourish under
just about any possible future.
Getting into your competitors head
Hugh Courtney, John T. Horn,
and Jayanti Kar
February 2009
To anticipate the moves of your rivals, you
must understand how their strategists and decision
makers think.
The use and abuse of scenarios
Charles Roxburgh
November 2009
Although it is surprisingly hard to create good ones,
they help you ask the right questions and prepare for
the unexpected. That is hugely valuable.
A fresh look at strategy under
uncertainty: An interview
December 2008
Although even the highest levels of uncertainty
dont prevent businesses from analyzing predicaments
rationally, says author Hugh Courtney, the fnancial
crisis has shown us the limits of our toolsand minds.
Rebuilding corporate reputations
Sheila Bonini, David Court, and Alberto Marchir
June 2009
A perfect storm has hit the standing of big business.
Companies must step up their reputation-management
efforts in response.
Using power curves to assess
industry dynamics
Michele Zanini
November 2008
A new way of looking at industry structures reveals
startling patterns of inequality among even the largest
companies.
Introduction
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Copyright 2010 McKinsey & Company. All rights reserved.
3
Introduction
In times of economic uncertainty, strategy becomes more
important than everyet harder than ever to formulate. Our new
bonus reader, with articles both by McKinsey consultants
and outside experts, not only examines the underlying principles
of strategy for these hard, confusing times but also explains
practical tools and techniques that executives can use to develop
their own strategies.
These pieces, exemplifying the Quarterlys best traditions,
offer new ways of thinking about the challenges facing companies
and managers. They represent just a small sampling of the
knowledge and ideas available to you as a Premium Member of
McKinsey Quarterly.
4
There is nothing like a crisis to clarify the mind. In suddenly volatile
and different times, you must have a strategy. I dont mean most of the
things people call strategymission statements, audacious goals, three-
to fve-year budget plans. I mean a real strategy.
For many managers, the word has become a verbal tic. Business lingo
has transformed marketing into marketing strategy, data processing into
IT strategy, acquisitions into growth strategy. Cut prices and you have
a low-price strategy. Equating strategy with success, audacity, or ambi-
tion creates still more confusion. A lot of people label anything that
bears the CEOs signature as strategica defnition based on the deciders
pay grade, not the decision.
By strategy, I mean a cohesive response to a challenge. A real strategy is
neither a document nor a forecast but rather an overall approach based
on a diagnosis of a challenge. The most important element of a strategy
is a coherent viewpoint about the forces at work, not a plan.
Whats happening?
The past years events have been surprising but not novel. Historically,
land bubbles, easy credit, and high leverage often make a dangerous
mixture. Real-estate debt triggered the frst US depression, in 1819. A
land mortgage boom was directly behind the 187377 crisis: innova-
Richard P. Rumelt
During hard times, a structural break in the economy
is an opportunity in disguise. To surviveand,
eventually, to fourishcompanies must learn to
exploit it.
Strategy in a
structural break
Richard Rumelt is the
Harry and Elsa Kunin
professor of business and
society at the Anderson
School of Management,
University of California at
Los Angeles.
Strategy | By Invitation: Insights and opinion from outside contributors
McKinsey Quarterly 2009 Number 1 5
tive forms of mortgage lending in Europe and the United States generated
an unsustainable boom in land prices, and a four-year global depres-
sion followed their collapse and the accompanying credit crunch.
Another credit crunch, this one triggered by the failure of traded
railroad notes, led to the Long Depression of 189397. Japans 1995
2004 lost decade followed a period of high leverage and wildly
infated land values brought to an end by a fnancial crash.
Leverage lies at the heart of such stories. Archimedes said, Give me
a lever long enough and a fulcrum strong enough, and I will move
the world. He didnt add that it would take a lever many light years
long to move the Earth by the width of an atom, and if the Earth
twitched, the kickback from the lever would fing him far and fast. The
current crisis is about kickback from leverage in two places: house-
holds and fnancial services. Without leverage, downturns would be
disappointments, but mortgages would not be foreclosed nor com-
panies bankrupt. Leverage spreads the pain in ever-widening waves.
The way these dynamics played out is well known. US household debt
started rising in the early 1980s, and its growth accelerated in 2001
(Exhibit 1). Leverage among Wall Streets fve largest brokerdealers
(Goldman Sachs, Merrill Lynch, Lehman Brothers, Bear Stearns,
and Morgan Stanley) rose dramatically after 2004, when the US Securi-
ties and Exchange Commission exempted these frms from the long-
standing 12-to-1 leverage ratio limit and let them regulate themselves.
From 1990 to 2007, the whole fnancial-services sector expanded
2.5 times faster than overall GDP, and its profts rose from their 194796
average of 0.75 percent of GDP to 2.5 percent in 2007. Then falling
e x h i b i t 1
The runaway US consumer
Ratio of consumer debt to
disposable income
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0
1952 1962 1972 1982 1992 2002 2007
Souice: US Buieau o Lconomic Analysis: US Ieueial Reseive
Top of sand background
Baseline for unit of
measure/subtitle
r x n i v i 1 i
Exhibit title
6 Strategy in a structural break
home prices led to an unanticipated rise in foreclosure rates and a drop
in the value of certain mortgage-backed securities. That decline
quickly undid highly leveraged fnancial frms, whose failure spread
loss and uncertainty throughout the system. US consumer spending
continued at a high level through the frst half of 2008 but by the third
quarter had dropped at a 3.1 percent annualized rate. A recession
potentially a deep onehad arrived.
A structural break
Discerning the signifcance of these events is harder than recounting
them. I think we are looking at a structural break with the past
a phrase from econometrics, where it denotes the moment in time-
series data when trends and the patterns of associations among
variables change.
A corporate crisis is often a sign that the companys business model
has petered outthat the industrys underlying structure has changed
dramatically, so old ways of doing business no longer work. In
the 1990s, for instance, IBMs basic model of layering options and peri-
pherals atop an integrated line of mainframe computers began to
fail. Demand for computing was up, but IBMs way of providing it
was down. Likewise, newspapers are now in crisis as the Internet
grabs their readers and ads. Demand for information and analysis is
increasing, but traditional publishing vehicles have diffculty mak-
ing money from it.
The same principle applies to the economy as a whole. In most of the
recessions of the past 40 years, demand caught up with capacity
and growth returned in 10 to 18 months. This recession feels different
because it is hard to imagine the full-steam reexpansion of fnancial
services or a rapid turnaround in housing. Beyond these two hot spots,
there seem to be unsustainable trends in commodity prices, oil
imports, the nations trade balance, the state of our schools, and large
entitlement promises. Already, the idea that the United States can
grow by borrowing money from China to fnance consumption at home
has begun to seem implausible. We know in our bones that the
future will be different. When the business model of part or all of the
economy shifts in this way, we can speak of a structural break.
Such a break often means hard times. Adjustment is neither easy nor
quick. Diffcult and volatile conditions wipe out some organizations
yet others prosper because they understand how to exploit the fact
that old patterns vanish and new ones emerge. The frst order of the day
is to survive any downturns in the real economy (see sidebar, Hard-
times survival guide), but the second is to beneft from these new pat-
terns. A structural break is the very best time to be a strategist, for
at the moment of change old sources of competitive advantage weaken
and new sources appear. Afterward, upstarts can leap ahead of seem-
ingly entrenched players.
In several industry sectors, the most recent structural break occurred
in the 1980s, with the development of microprocessors, which led
to much cheaper computing, personal and desktop computers, and the
rise of a new kind of software industry. Those innovations begat the
Internet and electronic commerce. More important for strategists,
the break shifted the nature of competitive advantage dramatically. In
1985, for example, a telecom-equipment company needed suff-
cient scale to serve at least two of the three main continentsAsia,
Europe, and North Americaand skill at coordinating thousands
of development engineers, manufacturing engineers, and workers. By
1995, frmware had become the primary source of advantage. Cisco
Systems came out of nowhere to dominate its whole industry segment
by deploying what at frst was about 100,000 lines of elegant code
written by a small team of talented people. That structural break
allowed Silicon Valleys small-team culture to overtake Japans
advantages in industrial engineering and in managing a large, disci-
plined workforce. This shift in the logic of advantage changed the
wealth of nations.
Structural breaks render obsolete many existing patterns of behavior,
yet they point the way forward for some companies and at times
even for whole economies. The Long Depression of 189397 marked
the end of the railroad boom, for example, and the start of the
transition to an economy based on sophisticated consumer goods.
Milton Hershey built his early chocolate brand and distribution
advantages in the middle of those hard times. GE was a product of
the same period, for the structural break also marked the rise of a
new economy based on electricity.
Although the 1930s were very hard times for the United States, not
every industry or business declined. As the economy shifted massively
from capital goods to consumer goods, some industriessuch as steel,
rubber, coal, glass, railroads, and buildingsuffered greatly, but
consumer brands such as Kelloggs hit their stride. Campgrounds and
motels blossomed along highways. Airline passenger traffc grew
robustly. Entertainment surged with the growth of the radio and movie
industries, and of their audience, during the Golden Age of Hollywood.
Likewise, during the decade from 1996 to 2005, overall consumer
spending remained fairly fat in Japan. Still, the economy rotated into
new things. The country, for example, has more than 200 brands of
soft drinks, and each of Seven-Eleven Japans small convenience stores
carries more than 50 at any time. About 70 percent of these brands
vanish each year and are replaced by new ones.
Many aspects of such structural changes will depend upon the govern-
ments policy response. Today, nuclear power, infrastructure repair,
and fber to the home are already on the list of possible stimuli for the
economy. In examining such business opportunities, its important to
recognize that competition for government funds is ferce. Nonetheless,
the state can provide frst-mover advantages in new growth areas.
During Franklin Roosevelts New Deal, for example, the federal govern-
ment vastly expanded its record keeping. Since it needed something
better than handwritten or typed notes, it turned to IBMs new-fangled
punch card system. In the growth industry of aviation, Boeing lost
its airline business as a result of the Air Mail Act of 1934 but also built
substantial advantages by performing well on key military contracts.
The wrong way forward in a structural break during hard times is to
try more of the same. The break and the hard times are sure indi-
cations that an old pattern has already been pushed to its limits and is
destroying value. As an example of such a pattern, consider the
fnancial sectors compensation incentives. Decades of careful research
shows no evidence that anything but luck explains why some fund
managers outperform others. Yet fund and even pension fund managers
who supposedly outperform get huge pay and bonuses. Incentives are
If you cant survive hard times, sell out
early. Once you are in fnancial distress, you
will have no bargaining power at all.
In hard times, save the core at the expense
of the periphery. When times improve, recap-
ture the periphery if it is still worthwhile.
Any stable source of good proftsany
competitive advantageattracts overhead,
clutter, and cross-subsidies in good times.
You can survive this kind of waste in such
times. In hard times, you cant and must
cut it.
If hard times have a good side, its the
pressure to cut expenses and fnd new
effciencies. Cuts and changes that raised
interpersonal hackles in good times can be
made in hard ones.
Use hard times to concentrate on and
strengthen your competitive advantage. If
you are confused about this concept, hard
times will clarify it. Competitive advantage
has two branches, both growing from the
same root. You have a competitive advantage
when you can take business away from
another company at a proft and when your
cash costs of doing business are low enough
that you can survive in hard times.

Take advantage of hard times to buy the
assets of distressed competitors at bargain-
basement prices. The best assets are com-
petitive advantages unwisely encumbered
with debt and clutter.
In hard times, many suppliers are willing to
renegotiate terms. Dont be shy.
In hard times, your buyers will want better
terms. They might settle for rapid, reliable
payments.
Focus on the employees and communities
you will keep through the hard times. Good
relations with people you have retained
and helped will be repaid many times over
when the good times return.
Hard-times survival guide
good in principle, but did Bear Stearns get competent risk management
in return for the $4.4 billion bonus pool it distributed in 2006? Does any
organization have to give its CEO a $40 million bonus to secure his
services? If you pay people enough money to make any future payment
beside the point, dont be surprised when they take vast long-term
risks for short-term wins. In almost any pattern, overshooting produces
negative returns.
Another pattern that may generate diminished or negative returns is
the baffing complexity of our business and management systems.
The fnancial-services industry is a poster child for the costs of this
kind of complexity, as well. Calls to regulate such complex systems
are misguidedregulators cant comprehend them if their creators
dont. The best regulators can do in this case is to ban certain kinds
of behavior.
Complexity also manifests itself in the soaring volume of e-mail. Philip
Su, a Windows Vista software engineering manager, reports that the
intensity of coordination on this project created a phenomenon by
which process engenders further process, eventually becoming a
self-sustaining buzz.
1
We have all experienced this unanticipated side
effect of apparently cheap communications. Unfortunately, lower-
ing the cost of sending a message dramatically increases the amount
of messaging. E-mail to a group of coworkers triggers immediate
1
See Philip Su, The world as best as I remember it, blogs.msdn.com/philipsu.
e x h i b i t 2
The rising cost of administration
Share of selling, general, and administrative
(SG&A) costs to sales, %
35
30
25
20
15
10
5
0
1950 1960 1970 1980 1990 2000 2007
Source: Standard & Poors
responses, the group of respondents expands, and responses proliferate
like neutrons in a critical mass of plutonium. Messages are requests
to do something, change something, or look at something. All that has
a high cost. It was in the 1980s, as computing became a necessary
part of the paraphernalia of management, that the percentage of pretax
expenses accounted for by selling, general, and administrative costs
(SG&A) began to accelerate (Exhibit 2).
In part, this rising administrative intensity shows the increasing impor-
tance of knowledge-based workers and the outsourcing of manual
labor. It also refects a more intense commitment to very complex sys-
tems comprising individual parts whose productivity is almost
impossible to measure. Despite the claims of IT, marketing, and human
resources that their programs generate strong returns on investment,
corporations are betting on a whole approach to business, not on any
one element. The risk is that in hard times, the system becomes
the problem.
Consider an analogy. When oil is cheap and plentiful, we create a vast
infrastructure that works well if oil remains cheap and plentiful.
When it becomes expensive, we wish we had a different infrastructure.
Similarly, when economic opportunities abound, we invest in a
management infrastructure that harvests them very well. When the
feld of opportunities becomes less verdant, we must change our
management infrastructure. A system that requires companies to spend
at least $300,000 a year in wages, benefts, support personnel, and
systems to enable one educated person to do his or her job could be
unsustainable in a less luxuriant world.
2

Doing things differently
Its hard to fx infrastructure when times are good and demand is
growing. From 1993 to 1995, I served as director of INSEADs
Corporate Renewal Initiative, which studied and worked with com-
panies trying to become more competitive. As business turned
up in 1996, the interests of these companies fipped, as if by a switch,
from reengineering to growth.
In the years since, most companies have indeed grown. They have also
spent money on increasingly complex overhead structures to address
the diversity of products and geographies and the demands of employees
and governments. Now, in hard times, scope and variety will be cut,
but costs wont automatically follow. The costs of managing scope and
variety have been baked into the infrastructureIT systems, sourc-
ing systems, and processes for designing and marketing new products.
2
As a baseline, US elementary and secondary educational systems spend about $250,000 a year on each
class of average size (23 students). Another interesting data point: the US military spends $350,000
to $700,000 a year, depending on whose fgures you believe, to put one soldier on the ground in Iraq.
So during structural breaks in hard times, cutting costs isnt enough.
Things have to be done differently, and on two levels: reducing the
complexity of corporate structures and transforming business models.
At the corporate level, the frst commandment is to simplify and
simplify again. Since companies must become more modular and diverse,
eliminate coordinating committees, review boards, and other mecha-
nisms connecting businesses, products, or geographies. The aim of
these cuts is to provide lean central and support services that dont
require business units to spend time and energy coordinating their
activities. Break larger units into smaller ones to reveal cross-subsidies
and to break political blockades. You may think that coordina-
tion costs will rise if you fragment the business, but you must do so
to expose what ought to be streamlined.
Then start reforming individual businesses. There is a large and useful
body of knowledge about how to go about doing so, and this is not
the place to reprise it. In general terms, the frst task is to understand
how a business has survived, competed, and made money in the
past. Dont settle for PowerPoint bar charts and graphs. If the business
is too complex to comprehend, break it into comprehensible parts.
Once you gain this critical understanding, you can start the work of
reshaping. There is no magic formula. Reforming a business always
takes insight and imagination.
In ordinary hard times, the traditional moves are reducing fxed costs,
scope, and variety. But in hard times accompanied by structural
breaks, you must rethink the way you manage. Companies that survive
and go on to prosper look beyond costs to the detailed structure of
managerial work. Several new issues come to the forefront:
How much extra work results from the way incentive and
evaluation systems relentlessly pressure managers to look busy
and outperform one another?
Which information fows can you omit? Information that doesnt

inform value-creating decisions is a wasteful distraction.
Which decisions and judgments can you standardize as policy

rather than make in costly meetings and communications?
How can you work with customers, suppliers, and the govern-
ment to simplify their processes so that you can simplify yours?
Recessions are neither good for the economy nor morally uplifting.
But since we are diving into a period of neck-snapping change, we had
better start the process of reformation before its too late.
Copyright 2009
McKinsey & Company.
All rights reserved.
We welcome your
comments on this article.
Please send them to
quarterly_comments@
mckinsey.com.
12
D E C E MB E R 2 0 0 9
Dynamic management:
Better decisions in uncertain times
Companies cant predict the future, but they can build
organizations that will survive and flourish under just about
any possible future.
Lowell Bryan
s t r a t e g y p r a c t i c e
13
The economic shock of 2008, and the Great Recession that followed, didnt just
create profound uncertainty over the direction of the global economy. They also shook the
confdence of many business leaders in their ability to see the future well enough to take
bold action.
Its not as if we dont know how to make good decisions under uncertainty. The US Army
developed scenario planning and war gaming in the 1950s. And advanced quantitative
techniques, complete with decision trees and probability-based net-present-value (NPV)
calculations, have been taught to MBA students since the 1960s. These approaches are
extraordinarily valuable amid todays volatility, and many well-run companies have
adopted them, over the years, for activities such as capital budgeting.
Heres the challenge: coping with uncertainty demands more than just the thoughtful
analysis generated by these approaches (which, in any event, are rarely employed for all the
business decisions where they would be useful). Profound uncertainty also amplifes the
importance of making decisions when the time is rightthat is to say, at the moment when
the fog has lifted enough to make the choice more than a crap shoot, but before things are
clear to everyone, including competitors.
Over the past year or so, progressive strategists have been undertaking noble experiments
(such as shorter fnancial-planning cycles) while dropping the pretense that they can
make reasonable assumptions about the future. My sense, though, is that achieving truly
dynamic management will prove elusive for most organizations until they can fgure
out how to get their senior leadership (say, the top 150 managers) working together in
a fundamentally different way. The knowledge, skill, and experience of these leaders
make them better suited than anyone else to act decisively when the time is right. Such
executives are also well placed to build the organizational capabilities needed to surface
critical issues early and then use the extra lead time to gather intelligence, to conduct the
needed analyses, and to debate their implications.
The specifcs of how companies should build these muscles will of course vary. Well-run
organizationsparticularly those accustomed to using stage-gate-investment approaches
for activities such as oil exploration, venture capital investment, and new-product
developmentmay fnd that moving toward a more dynamic management style requires
a few relatively small, though collectively signifcant, shifts in their operating practices.
Others may fnd the necessary changes, which include migrating away from rigid,
calendar-based approaches to budgeting and planning, more wrenching. What I hope to do
in this article is to lay out some core principles that will help either kind of company make
the passage of time an ally rather than a challenge.
For more on strategic
planning, see Navigating
the new normal: A
conversation with four
chief strategy offcers, on
mckinseyquarterly.com.
14
Focusing on pivotal roles
A ship has a captain with a single mind. The captain of a large, complex modern
corporation is likely to be dozens, if not hundreds, of people. Aligning those pivotal leaders
so that they can steer the company in response to changing conditions is a major challenge
for most organizations.
An essential frst step is simply to defne who occupies the pivotal roles. Some companies
may have just a few; others 20, 150, or even more. On the one hand, the smaller the
number, the easier it is to have the intensity of interaction needed to make critical
decisions effectively and collaboratively. On the other hand, the number must be large
enough so that the people involved in decision making can collectively access the full
spectrum of knowledge embedded in a companys people and its relationships with
other organizations. Youll never get perfect coverage, but if you wind up saying with any
frequency, Were fying blind on this topic without perspective from X, its a good bet that
youve kept the group too small.
Since determining what to do under uncertainty usually requires careful debate among
many people across the entire company, you need processes and protocols to determine
how issues are raised, how deliberation is conducted, and how decisions are made. You
also need to clearly lay out the obligations of managers, once the debate and decision
making is over, to put their full weight behind making the resulting actions successful.
I wish there were one-size-fts-all protocols for getting the smart, talented people who
occupy pivotal roles (and who are accustomed to making decisions through a hierarchy) to
work effectively with colleagues in collectively steering the ship. But the hard truth is that
what works in one organization and among one set of individuals may not work in others.
Since the move toward more dynamic management changes power relationships and
the prerogatives of senior executives, a companys organizational, cultural, and political
norms have a major infuence on the ease of transition. (The more hierarchical and less
collaborative the organization, for example, the bigger the challenge.) The best I can do
is to suggest a few general approacheswhose implementation often looks quite different
in different types of organizationsfor helping the individuals occupying pivotal roles to
work together in new ways.
Learning by doing
If you require managers to use decision-making-under-uncertainty techniques (such as
scenario planning, decision trees, and stage gating) to make actual decisions, they will
quickly learn how to think differently about the future. And if you have them apply these
tools in teams involving executives from diverse corners of the organization, they will
gain a greater appreciation for the power of collective insight in volatile times, when
information, almost by defnition, is fragmentary and fast moving.
15
Workshop-based adult-learning techniques
Executives can develop new mind-sets and skills, particularly to improve their ability to
manage through the ambiguity and complexity inherent in todays environment. Some
companies have made progress by developing case studies based upon potential decisions
they will shortly be facing and then using facilitators and friendly colleagues to get
leaders used to surfacing and debating alternative courses of action. Others have found
war gaming useful for illustrating the cost of basing decisions on seemingly reasonable
assumptions when events are moving quickly.
Performance measurement
Companies need to hold their managers not just individually but also mutually
accountable for their actions. This means evaluating how effectively executives contribute
to the success of others. For example, how effective are executives at identifying the
companys critical issues, even when such issues fall outside their areas of responsibility?
And how proactively do executives provide their colleagues with intelligence, knowledge,
and advice? Peer-assessment techniques often are invaluable in measuring collaborative
behavior.
Just-in-time decision making
Much of the art of decision making under uncertainty is getting the timing right. If you
delay too much, opportunity costs may rise, investment costs may escalate, and losses
can accumulate. However, making critical decisions too early can lead to bad choices or
excessive risks. And making hasty decisions under time pressure or economic duress
allows little room to undertake detailed staff work or to engage in careful debate. Here are
a few suggestions for companies trying to create competitive advantage from their ability
to manage the passage of time decisively.
Surfacing critical issues
Most companies are accustomed to identifying major internal issues, such as whether
to build a business, divest an asset, or lay off people. Whats harderand has become
increasingly important over the past year or sois the early surfacing of opportunities
and threats arising out of external events such as dramatic shifts in demand, competitive
behavior, industry structure, regulation, or the macroeconomic environment.
A commonsense approach to identifying such issues early is to poll, regularly, all of the
companys top managers to get them to identify critical issues they see emerging. Each
manager should provide a rationale for why any issues raised are critical. A small team
of senior executives should review all such issues, designating some as critical and
highlighting others for continued tracking. As time passes, some of these other issues may
become critical; others may become less relevant and disappear from the list.
16
One challenge: many managers are reluctant to surface emerging issues early, because
they fear being perceived as someone who is weak, or who cries wolf. A well-designed
performance-management system, though, can ensure that the personal risk of surfacing
critical issues late is much greater than the risk of raising them too early.
Performing the necessary staff work
If a critical issue is surfaced early, there is usually time enough to use proven problem-
solving approaches to making decisions under uncertainty. Decision trees, for example,
help managers think about the structuring and sequencing of their decisions. Probabilistic
modeling is useful for understanding the economic consequences of potential outcomes.
Breaking big decisions into smaller, well-sequenced ones (the goal of stage-gate investing)
helps organizations move forward without taking excessive risks. And building scenarios
helps you gain perspective on your critical issues. If a particular decision produces
favorable outcomes under all scenarios, it becomes a no regrets move justifying
bold action. On the other hand, if a particular scenario is improbable, but the negative
consequence (if it happens) is large, you need to build contingency plans.
If companies tried to make all or even most of their important decisions in this way, the
costs could be prohibitive, and there wouldnt be enough management bandwidth available
to do anything but debate issues. Employing a materiality test, such as whether 1 or 2
percent of a companys future earnings are at stake, is therefore vital. In a typical large
company, this may mean no more than two or three dozen such issues in any given year.
Changing how decisions are made
Few companies are organized to get just-in-time managerial alignment for even a few
issues a year, let alone two or three dozen. Gaining alignment among pivotal decision
makers requires them to spend time together (in person, by phone, or in videoconferences)
to surface emerging issues, share information, debate issues, and make timely decisions.
How much time is needed for such meetings will, of course, vary with the company and its
circumstances but is likely to be in the range of two to three days a month.
The only way to make this happen is to redesign the corporate calendar, along with
corporate processes and protocols for how the meetings are conducted (including their
length, decision-making roles, and required attendees). The redesign should encompass
the creation of processes that enable the rapid surfacing and formal designation of issues
considered critical. In addition, some companies have found it helpful to create a situation
rooma physical place manned by support staff and connected electronically to people
who cant be physically presentto serve as a hub to mobilize the information needed to
enable debate to take place in real time among the appropriate decision makers.
For more on scenario
planning, see The use and
abuse of scenarios, on
mckinseyquarterly.com.
17
Rethinking corporate budgeting processes
Everything Ive been describing fies in the face of management practices that have proven
invaluable at many companies for nearly a century. However, fxed annual planning and
budget processes are antithetical to timely strategy setting and decision making.
Yet its important to recall why we have them: they enable the effcient delegation of
authority between managers and subordinates. In return for the freedom to make
decisions and allocate resources, the subordinate contracts through the budget to deliver
expected results. The managers of a large company make tens of thousands of operating
decisions every day, and if all of them required constant deliberations up and down the
chain of command and across the organization, it would grind to a halt.
Jettisoning budgeting, therefore, is hardly an optionthough it may have seemed
reasonable at points over the past year, since most of the budgets produced in late 2008 for
2009 proved worthless (as did most companies earnings guidance to stock analysts). What
this underscores is a basic problem with budgets: if developments in the marketplace are
suffciently different from the assumptions used in budgeting, managers cant make their
numbers no matter what they do. At best, by the time these developments have surfaced to
the top, most of the lead time needed to address the emerging issues has been exhausted.
At worst, the company faces a crisis after being weakened by the hidden costs of all of
the short-term actions (such as maintenance cutbacks for manufacturers or excessive
risk taking for fnancial institutions) undertaken by managers endeavoring to make their
numbers.
So whats the answer? Many better-run companies have already adapted the budgeting
process to make it more fexible. A large number use a base case, an optimistic case, and a
pessimistic case to allow for a range of outcomes. More important, a signifcant percentage
of companies now use rolling budgets to keep their plans current. These approaches arent
foolproofmany companies fall into the trap of using too narrow a range (such as plus
or minus 5 percent), and even companies that use rolling budgets usually do so only by
making small incremental adjustments, quarter to quarter, to the base case. Nonetheless,
in a relatively stable environment, these approaches are a signifcant step forward.
But even rolling budgeting may not be enough to prepare you for a macroenvironment
where you are unsure whether you will be seeing, over the next couple of years, a rapid
return to global growth, an extended period of anemic growth, or a double-dip recession.
One alternative: move to a semiannual budgeting and fnancial-planning cycle where you
make budget contracts for a 6-month, rather than annual, time period and undertake
robust, scenario-based fnancial-contingency planning for the period from 6 to 24 months
in the future. That approach allows companies both to continue using budgets that hold
people accountable for the immediate future and to shift toward contingency budgets at
18
the end of 6 months should the circumstances warrant a change of direction. I believe
many companies will fnd that a semiannual budgeting process works better than either an
annual approach, which is based upon an unrealistic year-long budget-contracting horizon,
or a quarterly update, which requires almost continuous rebudgeting.
Another valuable and potentially complementary approach is to have even 6-month
budgets and the results reported against them automatically adjusted for uncontrollables.
That is, to improve accountability you can restate both budgets and results after the fact
to remove, automatically, variances caused by macroeconomic uncontrollables such as
interest rates, commodity prices, and currency movements. This approach can help senior
leaders eliminate uncontrollable losses and windfall gains, thereby holding managers
accountable for their performance in the marketplace rather than for whether the
macroeconomy makes them lucky or unlucky.
Finally, many if not most companies will also fnd that they need to carve out discretionary
budgets and staff to support just-in-time decision making. These budgets should be
suffcient not just to support the needed staff work but also to provide the resources
needed to begin implementing the decisions until they (and their fnancial implications)
can be formally built into budgets.
Companies cant control the weather, but they can design and build a ship, and equip it
with a leadership team, that can navigate the ocean under all weather conditions. Organi-
zations that become more fexible and skillful at making critical decisions when the
timing is right have enormous opportunities to capture markets and profts from companies
that persist in managing as if the future business environment is reasonably predictable.
Lowell Bryan is a director in McKinseys New York offce. Copyright 2009 McKinsey & Company. All right reserved.
Related articles

Leading through
uncertainty
Setting strategy in the
new era: A conversation
with Lowell Bryan
and Richard Rumelt
How managers should
approach a fragile
economy
Strategic planning: Three
tips for 2009
20 Getting into your competitors head
Getting into your
competitors head
To anticipate the moves of your rivals, you must understand how their
strategists and decision makers think.
Hugh Courtney, John T. Horn,
and Jayanti Kar
The global financial crisis that erupted in 2008 shows, with painful
clarity, that we live in an interdependent business world. In bleak times
and fair, the success of a companys strategy often depends greatly on the
strategies of its competitors. In periods of fnancial turmoil, for instance,
the prospectsand even survivalof a bank often depend on the near-
term M&A of its rivals. Similarly, the ultimate success of Boeings
new commercial jet, the 787 Dreamliner, will depend on the way Airbus
positions, markets, and sells its new and competing A380 and A350.
Pfzers ability to sustain market share and proftability in the market for
cholesterol-lowering treatments will depend on the moves of the com-
panys branded and generic pharmaceutical competitors, to say nothing of
biotech and medical-product companies developing alternative treatments.
This strategic interdependence implies that the ability to anticipate your
competitors strategies is essential. Yet a recent survey of business executives
found that the actions and reactions of potential rivals almost never play
a role in, for example, decisions to introduce and price new products.
1
An
important reason for this neglect, we believe, is that strategic-planning
tools, such as game theory and scenario planning, are of limited use unless
a company can correctly defne the key elements of the strategic game,
K
e
i
t
h

N
e
g
l
e
y
Strategy
1
David Montgomery, Marian Chapman Moore, and Joel Urbany, Reasoning about competitive reactions:
Evidence from executives, Marketing Science, 2005, Volume 24, Number 1, pp. 13849.
especially the strategic options and objectives of competitors. This is no
easy task. Rare is the company that truly understands what its competitors
and their decision makers care about most, how they perceive their assets
and capabilities, and what all this means for their strategies. A company
with such insights could reverse-engineer the moves of competitors and
predict what they were likely to do. In a credit crunch, for instance, such
a company would be well positioned to buy fnancial and nonfnancial
assets at attractive prices if it knew that poorly capitalized competitors
would avoid new risk and therefore not bid for these assets.
Getting inside your competitors head is diffcult because companies (and
their decision makers) usually are not alike. At any time, a company
has assets, resources, market positions, and capabilities it must protect,
leverage, and build upon. Different endowments imply different strate-
gies even in the same general market environment. Whats more, even a
competitor with similar endowments may pursue different strategies
if its owners, stakeholders, and decision makers have a different objective.
So if you want to anticipate rather than react to strategic moves, you must
analyze a competitor at two levels: organizational and individual. At the
organizational level, you have to think like a strategist of your competitor
by searching for the perfect strategic ft between its endowments and its
changing market environment. At the individual level, you have to think
like the decision makers of the competitor, identifying who among them
makes which decisions and the infuences and incentives guiding their
choices. This approach moves you beyond the data-gathering efforts
of most competitive-intelligence functions, toward a thought process that
helps turn competitive intelligence into competitive insights. While our
approach wont eliminate surprises, it will help you better understand your
competitors and their likely moves and eliminate some of the guesswork
that undermines the development of strategies in an increasingly interdepen-
dent business world.
Think like your competitors strategist
When your competitor resembles you, chances are it will pursue similar
strategieswhat we call symmetric competition. When companies
have different assets, resources, capabilities, and market positions, they
will probably react to the same market opportunities and threats in
different wayswhat we call asymmetric competition. One of the keys to
predicting a competitors future strategies is to understand how much
or little it resembles your company.
In the fast-food industry, for example, two leading players, McDonalds
and Burger King, face the same market trends but have responded in
markedly different ways to the obesity backlash. McDonalds has rolled
out a variety of foods it promotes as healthy. Burger King has introduced
high-fat, high-calorie sandwiches supported by in-your-face, politically
incorrect ads. As the dominant player, McDonalds is the lightning rod for
the consumer and government backlash on obesity. It cant afford to
thumb its nose at these concerns. Smaller players like Burger King, realizing
this, see an opportunity to cherry-pick share in the less health-conscious
fast-food segment. Burger King competes asymmetrically.
Companies can determine whether they face symmetric or asymmetric
competition by using the resource-based view of strategy: the idea that they
should protect, leverage, extend, build, or acquire resources and capa-
bilities that are valuable, rare, and inimitable and that can be successfully
exploited. Resources come in three categories: tangible assets (for example,
physical, technological, fnancial, and human resources), intangible assets
(brands, reputation, and knowledge), and current market positions (access
to customers, economies of scale and scope, and experience). Capabilities
come in two categories: the ability both to identify and to exploit oppor-
tunities better than others do.
In the video-game-console business, the strategies of Microsoft and Sony,
which are attempting to dominate next-generation systems, are largely
predictablebased on each companys tangible and intangible assets and
current market position. Although the core businesses of the two
competitors will be affected by video game consoles differently, both sides
see them as potential digital hubs replacing some current stand-alone
consumer electronic devices, such as DVD players, and interconnecting
with high-defnition televisions, personal computers, MP3 players, digi-
tal cameras, and so forth.
For Sony, which has valuable businesses in consumer electronics and in
audio and video content, it is important to establish the PlayStation as the
living-room hub, so that any cannibalization of the companys consumer
electronics businesses comes from within. After the recent victory of Sonys
Blu-ray standard over Toshibas HD-DVD, Sony stands to realize a huge
payoff in future licensing revenues. The PlayStation, which plays only Blu-
ray disks, is thus one of the companys most important vehicles in driving
demand for Blu-ray gaming, video, and audio content.
Microsoft has limited hardware and content businesses but dominates
personal computers and network software. Establishing the Xbox as the
living-room hub would therefore help to protect and extend its software
businesses. For Microsoft, it is crucial that the digital living room of the
future should run on Microsoft software. If an Apple product became
the hub of future iHome living rooms, Microsofts software business
might suffer.
Sony and Microsoft therefore have different motives for fghting this con-
sole battle. Yet the current market positions (existing businesses and
economies of scope), tangible assets (patents, cash), and intangible assets
(knowledge, brands) of both companies suggest that they will compete
aggressively to win. It was predictable that they would produce consoles
which, so far, have been far superior technologically to previous systems
and interconnect seamlessly with the Internet, computers, and a wide variety
of consumer electronics devices. It was also predictable that both com-
panies would price their consoles below cost to establish an installed base
in the worlds living rooms quickly. The competition to win exclusive
access to the best third-party developers games, as well as consumer mind-
share, will also probably continue to be waged more aggressively than it
was in previous console generations. For Microsoft and Sony, the resource-
based view of strategy helps us to understand that this battle is about
far more than dominance in the video game industry and thus to identify
the aggressive strategies both are likely to follow.
Nintendo, in contrast, is largely a pure-play video game company and thus
an asymmetric competitor to Microsoft and Sony. The resource-based
view of strategy explains why Nintendos latest console, the Wii, focuses
primarily on the game-playing experience and isnt positioned as a digi-
tal hub for living rooms. The Wiis most innovative feature is therefore a new,
easy-to-use controller appealing to new and hardcore gamers alike. The
Wii has few of the expensive digital-hub features built into the rival consoles
and thus made its debut with a lower retail price.
Applying the resource-based view of strategy to competitors in a rigorous,
systematic, and fact-based way can help you identify the options they
will probably consider for any strategic issue. But if you want to gain better
insight into which of those options your competitors are likeliest to
choose, you have to move beyond a general analysis of their communications,
behavior, assets, and capabilities and also think about the personal per-
ceptions and incentives of their decision makers.
Think like your competitors decision makers
Since the objectives of corporate decision makers rarely align completely
with corporate objectives, companies often act in ways that seem incon-
sistent with their stated strategic intentions or with the unbiased assessments
of outsiders about the best paths for them to follow. So if you want to
predict the next moves of a competitor, you must often consider the prefer-
ences and incentives of its decision makers.
The key to getting inside the head of a competitor making any decision
is frst identifying who is most likely to make it and then fguring out how
the objectives and incentives of that person or group may infuence the
competitors actions. In most companies, owners and top managers make
divestment decisions, for example. Strategic pricing and service decisions
are often made, within broad corporate guidelines, by frontline sales person-
nel and managers.
Owners and other important stakeholders
The objectives of the person or group with a controlling interest in your
competitor probably have a major infuence on its strategy. Sometimes,
personal preferences are particularly relevant: its likely that Virgins pio-
neering foray into the commercial space travel industry partially refects
the adventurous tastes of its charismatic founder, Sir Richard Branson. For
family-owned or -controlled businessespublic or privatefamily
values, history, and relationships may drive strategy. A competitor owned
by a private-equity frm is likely to focus on near-term performance
improvements to generate cash and make the company more attractive to
buyers. While every private-equity frm is different, you can often fore-
cast the tactics any given one will take by studying its history, since many
such frms often repeat their successful strategies.
Other stakeholders may also profoundly infuence a companys strategy, so
it often pays to get inside their heads as well. You cant evaluate any large
strategic moves GM or Ford might make without considering the interests
of the United Auto Workers and how those interests might check or
facilitate such moves. The importance of nonowner stakeholders in driving
a companys strategy varies by country of origin too. If you compete
with a Chinese company, the Chinese government is often a critical stake-
holder. In Europe, environmental organizations and other nongovern-
mental stakeholders exert more power over corporate decision making than
they do in the United States.
Top-level management
Since the owners of companies hire top-level management to pursue the
owners strategic objectives, a Martian might think that managements
decisions refect those interests. Earthlings know that this may or may not
be true. Thats why you must study your competitors top team.
First, that analysis provides another source of insight into the objectives
of the companys owners. When James McNerney arrived at 3M in 2001,
for instance, he brought along his belief in GEs operating system, a
centralized change-management methodology that inspired GEs successful
approach to Six Sigma, globalization, and e-Business. If you were a 3M
competitor, McNerneys history suggested that he would try to turn 3M,
which had traditionally favored a fairly loose style of experimentation,
into a more operationally accountable company. His hiring signaled the
3M boards intention to focus more aggressively than before on costs
and quality. It surely came as no surprise to 3Ms board or to the companys
competitors that one of McNerneys frst strategic moves was to launch
a corporate Six Sigma program.
And of course, senior executives arent always perfect agents for a
companys owners, whose personal interests and incentives may differ from
theirs. Such agency problems quite commonly bedevil even companies
with the best governance practices, so it often pays to focus on the objectives
of senior leaders as well.
The objectives of organizations
Jay Barney, Firm resources and sustained
competitive advantage, Journal of Management,
1991, Volume 17, Number 1, pp. 99120.
David J. Collis and Cynthia A. Montgomery,
Competing on resources: Strategy in the
1990s, Harvard Business Review, July 1995,
Volume 73, Number 4, pp. 11928.
Kevin P. Coyne, Stephen J. D. Hall, and Patricia
Gorman Clifford, Is your core competence a
mirage? mckinseyquarterly.com, February 1997.
James G. March, Exploration and exploitation
in organizational learning, Organization Science,
1991, Volume 2, Number 1, pp. 7187.
The objectives of decision makers
Michael Jensen and Kevin J. Murphy, CEO
incentives: Its not how much you pay,
but how, Harvard Business Review, May 1990,
Volume 68, Number 3, pp. 13853.
Paul Milgrom and John Roberts, Economics,
Organization & Management, Englewood Cliffs, NJ:
Prentice Hall, 1992.
Game theory, scenario planning, and
simulations
Hugh G. Courtney, Games managers should
play, mckinseyquarterly.com, June 2000.
Hugh Courtney, 20/20 Foresight: Crafting Strategy
in an Uncertain World, Boston, MA: Harvard Business
School Press, 2001.
Anticipating business surprises
Kenneth G. McGee, Heads Up: How to Anticipate
Business Surprises and Seize Opportunities First,
Boston, MA: Harvard Business School Press, 2004.
Recommended reading
The works below help readers learn more about the ideas and procedures discussed in this article.
General managers and frontline employees
Competitors of a decentralized company must focus not only on the objec-
tives of its owner and corporate leaders but also on those of business unit
leaders, middle management, and even frontline staff. Until recently, for
example, Ford was decentralized, with each geographic region run
almost independently. Automotive competitors that wished to predict Fords
behavior would have needed to focus on the statements and actions of
each regional and brand manager, because the companys objectives could
vary from location to location and across divisions. But since Alan
Mullaly took over as CEO in 2006, he has moved to coordinate some deci-
sions and platforms across divisions and regions. Competitors must now
understand what is still decided by regional managers and what by Detroit.
For certain decisions, frontline employees and managers are also important,
especially if they make pricing, marketing, service, and operational
decisions that signifcantly infuence a companys competitive advantage.
Even if decision making is more centralized, the incentives of frontline
employees may be misaligned with the objectives of a companys owners or
senior leaders. Agency problems may inspire the front line to undercut
these objectives.
Suppose, for example, that the head of a division at one of your competitors
wants its commissioned sales force to promote a new product. If the
sales force is enjoying strong sales from established products, reps may hesi-
tate to risk their compensation to promote the new one. A knowledge
of such agency problemswhich can often be detected through the chatter
between your frontline sales force and the customers you share with
competitorscan have great strategic importance for your company. In this
case, agency problems will probably delay the point when the new pro-
duct wins signifcant sales. You could exploit that time lag to fortify your
own presence in the market and possibly to preempt the competitors
new offering.
Reach a point of view
What happens once you have a better sense of the options your competitors
may consider and the way they may evaluate those options?
Lets say that your companys market environment is relatively stable and
that you have much useful information about your main competitors
and their decision makers. You can then apply game theory to determine,
with considerable confdence, the strategies your competitors will prob-
ably follow to maximize their objectives, as well as the way your own choices
may infuence those strategies. Suppose, however, that even your best
efforts dont give you a clear picture of the resources of your competitors
or their decision makers objectives. Then it is often best to avoid try-
ing to predict the competitions exact behavior and instead to use scenario
planning to test your companys strategic possibilities.
In a fnancial crisis, for example, even the best competitive-intelligence
efforts may provide incomplete, excessively complex, or inconsistent
information on the competitions strategies and thus fail to support game
theory or scenario planning. We have found that one way of generat-
ing a point of view in such situations is to conduct war games. In these
exercises, each team, representing a specifc competitor, receives a fact
pack about that company and its decision makers. The teams then make
key strategic decisions for the companies they represent. Through several
rounds of competition, every team can act on its own strategies and react
to the moves of other teams. The war game forces the players to com-
bine incomplete, and perhaps inconsistent, information on competitors to
develop a point of view about which moves make the most and least sense
for them and are therefore the most and least likely moves for them to make.
No matter how thorough and insightful your analysis may be, two things
are almost sure to happen: your competitor will make some moves you
considered unlikely, and some of your data will quickly become obsolete.
When a competitor acts in unexpected ways, your company has a
crucial learning opportunity. Why were you wrong? Did you, say, miss an
important agency problem that undermined the execution of the strategy
you thought the competitor would follow? Did the market environment
change, creating new threats and opportunities for the competitor? Did
Web 2008
Developing competitive insights
Exhibit 1 of 1
Glance: Developing competitive insights must be continuous to support strategic planning and
decision-making.

Exhibit title: The competitor-insight loop
1 Listen to your competitor
Gather basic competitive
intelligencewhat are your
competitors saying?
Use pattern recognition
do recent moves and counter-
moves reveal strategy?
2 Think like a strategist
for your competitor
What are its assets, capabilities,
market positions?
How might it protect, extend,
and leverage them?
4 Synthesize, learn, and
repeat
Synthesize information
to a point of view
about which moves make
the most and least
sense for your competitor
Learn from ongoing
indicators and monitoring
Repeat
3 Think like the decision
makers for your competitor
Who is the likely decision maker?
Are the decision makers'
interests aligned with those of
the companys owners?

measure/subtitle

The competitor-insight loop
1
2
3
4
it bring in a new chairman or CEO? You must diagnose your mistakes,
learn from them, and ensure that you use the latest data to develop your
point of view.
Learning from your mistakes means managing these competitive-insight
activities as an ongoing process for real-time strategic planning and decision
making, not as an annual or biannual event in a bureaucratic planning
process. Particularly in dynamic markets, where companies have to make
decisions constantly, information about competitors must be updated as
soon as possible (exhibit).
One key to making this ongoing process more insightful is tapping into the
latest competitive intelligence dispersed throughout the frontline work-
force. An e-mail address, a blog, or a shared database could let sales reps
report on the latest pric-
ing, promotion, negotiation,
and sales tactics that
competitors use with key
customers or customer
segments. Engineers might
use such facilities to
report the latest product
pipeline rumors from
professional conferences. When possible, companies should also establish
appropriate information-sharing arrangements with key partners; sup-
pliers, for example, may provide the latest intelligence on future input prices.
As Ken McGee argues in Heads Up, most of the information needed
for sound business strategy decisions is already available. You just have to
create a process to capture and synthesize it meaningfully.
Particularly today, no company is an island. Those that most accurately
perceive the competitive landscape as it is and is likely to be in the future
have a distinct competitive advantage. Our processfocusing on changes
in the resources, decision-making structures, and compensation systems of
competitorsmoves beyond the usual updates on key market trends and
uncertainties. Its rewards are huge: fewer surprises from competitors and
more opportunities to shape markets to your own advantage.
Q
Hugh Courtney is an alumnus of McKinseys Washington, DC, offce, where
John Horn is a consultant; Jayanti Kar is a consultant in the Toronto offce. Copyright 2009
McKinsey & Company. All rights reserved.
We welcome your comments on this article.
Please send them to quarterly_comments@mckinsey.com.
Related articles on mckinseyquarterly.com
How companies respond to competitors:
A McKinsey Global Survey
How to improve strategic planning
Strategys strategist: An interview with Richard Rumelt
29
N OV E MB E R 2 0 0 9
The use and abuse of scenarios
Although it is surprisingly hard to create good ones, they help
you ask the right questions and prepare for the unexpected. That
is hugely valuable.
Charles Roxburgh
30
Scenarios are a powerful tool in the strategists armory. They are particularly useful
in developing strategies to navigate the kinds of extreme events we have recently seen
in the world economy. Scenarios enable the strategist to steer a course between the false
certainty of a single forecast and the confused paralysis that often strike in troubled times.
When well executed, scenarios boast a range of advantagesbut they can also set traps for
the unwary.
There is a signifcant amount of literature on scenarios: their origins in war games, their
pioneering use by Shell, how to construct them, how to move from scenarios to decisions,
and so on. Rather than attempt anything encyclopedic, which would require a book rather
than a short article, I have put forward my personal convictions, based on experience
in building scenarios over the past 25 years, about both the power and the dangers of
scenarios, and how to sidestep those dangers. I close with some rules of thumb that help
meand will, I hope, help youget the best out of scenarios.
The power of scenarios
Scenarios have three features that make them a particularly powerful tool for
understanding uncertainty and developing strategy accordingly.
Scenarios expand your thinking
You will think more broadly if you develop a range of possible outcomes, each backed
by the sequence of events that would lead to them. The exercise is particularly valuable
because of a human quirk that leads us to expect that the future will resemble the past
and that change will occur only gradually. By demonstrating howand whythings could
quite quickly become much better or worse, we increase our readiness for the range of
possibilities the future may hold. You are obliged to ask yourself why the past might not be
a helpful guide, and you may fnd some surprisingly compelling answers.
This quirk, along with other factors, was most powerfully illustrated in the recent
meltdown. Many fnancial modelers had used data going back only a few years and were
therefore entirely unprepared for what we have since seen. If they had asked themselves
why the recent past might not serve as a good guide to the future, they would have
remembered the Asian collapse of the late 1990s, the real-estate slump of the early 1990s,
the crash of October 1987, and so on. The very process of developing scenarios generates
deeper insight into the underlying drivers of change. Scenarios force companies to ask,
What would have to be true for the following outcome to emerge? As a result, they fnd
themselves testing a wide range of hypotheses involving changes in all sorts of underlying
drivers. They learn which drivers matter and which do notand what will actually affect
those that matter enough to change the scenario.
31
Scenarios uncover inevitable or near-inevitable futures
A suffciently broad scenario-building effort yields another valuable result. As the analysis
underlying each scenario proceeds, you often identify some particularly powerful drivers
of change. These drivers result in outcomes that are the inevitable consequence of events
that have already happened, or of trends that are already well developed. Shell, the pioneer
in scenario planning, described these as predetermined outcomes and captured the
essence of this idea with the saying, It has rained in the mountains, so it will food in the
plains. In developing scenarios, companies should search for predetermined outcomes
particularly unexpected ones, which are often the most powerful source of new insight
uncovered in the scenario-development process.
Broadly speaking, there are four kinds of predetermined outcomes: demographic trends,
economic action and reaction, the reversal of unsustainable trends, and scheduled events
(which may be beyond the typical planning horizon).
Demography is destiny. Changes in population size and structure are among the few
highly predictable aspects of the future. Some uncertainties exist (potential increases in
longevity, for example), but only at the margin. Sometimes, the effects of these trends are
far offas with Social Security in the United States todayso they are generally ignored.
When these trends grow near, however, their effects can be powerful indeed, as when the
baby boom generation is on the brink of leaving the workforce.
You canna change the laws of economics! Just as Scotty the engineer could not change
the laws of physics when Captain Kirk
1
demanded more warp speed, so business leaders
cannot assume away the laws of economics. If demand shoots up, prices will toowhich
will limit demand and drive increasing supplywith the result that demand, prices, or
both will drop. Nothing increases in price forever, in real terms. We recently saw oil
prices more than double and then sink back again by an equal amount. Price changes
of this scale inevitably drive supply and demand reactions in every relevant value chain.
As in physics, every economic action has a predetermined reaction. These reactions are
often ignored in business strategy. If uncovered through scenario planning, however, they
can generate powerful insights.

Trees dont grow to the sky. Business plans often extrapolate into the future trends that
are clearly unsustainable. Economies are fundamentally cyclical, so beware of politicians
bearing tales about the end of boom and bust. Equally, do not build a strategy based
on the claim that the business cycle has been tamed. Often, optimistic projections are
accompanied by bold claims of a new paradigm. Strategists need to be very cautious
about alleged new paradigms. The appearance of even a genuine new paradigm almost
1
For the uninitiated, Scotty and Captain Kirk are two characters from Star Trek, a famous US science fction television series
from the 1960s.
32
always results in a speculative bubble. The new economy was a good example. More
recently, securitization proved to be another sound idea that resulted in a speculative
bubble. And in the past, many new, innovative technologiesrailroads and radio, for
examplewere hailed as new paradigms and then promptly led to investment bubbles.
A useful test is to project a trend at least 25 years out. Then ask how long can this trend
really be sustained. Challenge yourself to try and prove why the shape of the future
should be so fundamentally different from the more cyclical past. Chances are you wont
be able to, and this will open your eyes to the possibility of a break in the trend.
Scheduled events may fall beyond typical planning horizons. There is also a simpler kind
of predetermined outcome that does not involve any unalterable laws: scenarios must
take into account scheduled events just beyond corporate planning horizons. A recent
example, the results of which we have already seen, is reset dates on adjustable-rate
mortgages. Well before the event, one could have predicted a spike in resets as mortgages
sold in 2005 and 2006the peak yearscompleted their low, three-year introductory
rates. Something bad was going to happen to the economy in 2008. Right now, there
is another important timetable to watch: the wave of large bond issues that has
resulted from banks having to refnance hundreds of billions of dollars of maturing debt.
Although these types of scheduled events ought to be common knowledge, they tend to
be overlooked in planning exercises because they fall beyond the next 12 to 18 months.
Scenarios should account for scheduled events that could have a big impact in the 2460
month time frame.
While some errors can be avoided by recalling certain fundamental economic and
demographic facts or scheduled events, problems of timing will continue to exist. Your
companys strategic planners may know that a massive dollar value of mortgages is about
to reset. But when will the market actually wake up to this reality? Financial services
cannot grow as a percentage of GDP forever. But at what percentage will this stop? We
didnt know before, and we still dont know today. Still, the realization that something
must happen, even if it is not clear when, leads to the inclusion of at least one scenario in
which, say, fnancial services stop growing sooner rather than later.
Scenarios protect against groupthink
Often, the power structure within companies inhibits the free fow of debate. People
in meetings typically agree with whatever the most senior person in the room says. In
particularly hierarchical companies, employees will wait for the most senior executive to
state an opinion before venturing their ownwhich then magically mirrors that of the
senior person. Scenarios allow companies to break out of this trap by providing a political
safe haven for contrarian thinking.
33
Scenarios allow people to challenge conventional wisdom
In large corporations, there is typically a very strong status quo bias. After all, large sums
of money, and many senior executives careers, have been invested in the core assumptions
underpinning the current strategywhich means that challenging these assumptions can
be diffcult. Scenarios provide a less threatening way to lay out alternative futures in which
these assumptions may no longer be true.
Avoiding the common traps in using scenarios
For all these benefts, there is a downside to scenarios. Inexperienced people and
companies are prone to fall into a number of traps.
Dont become paralyzed
Creating a range of scenarios that is appropriately broad, especially in todays uncertain
climate, can paralyze a companys leadership. The tendency to think we know what is
going to happen is in some ways a survival strategy: at least it makes us confdent in
our choices (however misplaced that confdence may be). In the face of a wide range of
possible outcomes, there is a risk of acting like the proverbial deer in the headlights: the
organization becomes confused and lacking in direction, and it changes nothing in its
behavior as an uncertain future bears down upon it.
The answer is to pick the scenario whose outcome seems most likely and to base a plan
upon that scenario. It should be buttressed with clear contingencies if another scenario
or one that hasnt been imaginedbegins to emerge instead. Ascertain the no regrets
moves that are sound under all scenarios or as many as possible. Ultimately, the existence
of multiple possibilities should not distract a company from having a clear plan.
Dont let scenarios muddy communications
The former CEO of a global industrial company once suggested that scenarios are an
abdication of leadership. His point was that a leader has to set a vision for the future and
persuade people to follow it. Great leaders do not paint four alternative views of the future
and then say, Follow me, although I admit Im not sure where we are going.
Leaders can use scenarios without abdicating their leadership responsibilities but
should not communicate with the organization via scenarios. You cannot stand up in
front of an organization and say, Things will be good, bad, or terrible, but I am not
sure which. Winston Churchills remarks about British aims in World War IIVictory
at all costs, victory in spite of all terror, victory however long and hard the road may
beare instructive. By insisting on only one fnal outcome, Churchill was not refusing
to acknowledge that a wide range of conditions might exist. What he did was to set forth
a goal that he regarded as what we would call robust under different scenarios. He was
acknowledging the range of uncertainties (however long and hard the road may be), and
he resisted overoptimism (which affected many bank CEOs early in the recent crisis).
34
A chief executive, a prime minister, or a president must provide clear and inspiring
leadership. That doesnt mean these leaders should not study and prepare for a number of
possibilities. Understanding the range of likely events will embolden corporate leaders to
feel prepared against most eventualities and allow those leaders to communicate a single,
bold goal convincingly.
One additional point about communication and scenarios is worth noting. Scenarios
can help leaders avoid looking stupid. A wide range of scenarioseven if not publicly
discussedcan help prevent leaders from making statements that can be proven wrong
if one of the more extreme scenarios unfolds. For instance, one fnancial regulator
boldly announced, early in the fnancial crisis, that its banking system was, at the time,
capitalized to a level that made it bulletproof under all reasonable scenariosonly to
announce, a few months later, that a further recapitalization was required. Similarly,
the head of a large bank confdently suggested that the downturn was in its fnal phases
shortly before the major indexes plummeted by 25 percent and we entered a new and even
more dangerous phase of the crisis. Many CEOs have given hostages to fortune; scenarios
would have helped them avoid doing so.
Dont rely on an excessively narrow set of outcomes
The astute reader will have noticed that the above-mentioned fnancial regulator managed
to embarrass itself even though it was using scenarios. One of the more dangerous traps of
using them is that they can induce a sense of complacency, of having all your bets covered.
In this regard at least, they are not so different from the value-at-risk models that left
bankers feeling that all was well with their businessesand for the same reason. Those
models typically gave bankers probabilistic projections of what would happen 99 percent
of the time. This induced a false sense of security about the potentially catastrophic effects
of an event with a 1 percent probability. Creating scenarios that do not cover the full range
of possibilities can leave you exposed exactly when scenarios provide most comfort.
One investment bank in 2001, for instance, modeled a 5 percent revenue decline as its
worst case, which proved far too optimistic given the downturn that followed. Even when
constructing scenarios, it is easy to be trapped by the past. We are typically too optimistic
going into a downturn and too pessimistic on the way out. No one is immune to this trap,
including professional builders of scenarios and the companies that use them. When the
economy is heading into a downturn, pessimistic scenarios should always be pushed
beyond what feels comfortable. When the economy has entered the downturn, there is a
need for scenarios that may seem unreasonably optimistic.
The breadth of a scenario set can be tested by identifying extreme eventslow-probability,
high-impact outcomesfrom the past 30 or 40 years and seeing whether the scenario set
contains anything comparable. Obviously, such an event would never be a core scenario.
But businesses ought to know what they would do, say, if some more virulent strain of
35
avian fu were to emerge or if an unexpected geopolitical confict exploded. Remember
too that it would not take a pandemic or a terrorist attack to threaten the survival of
many businesses. Sudden spikes in raw-material costs, unexpected price drops, major
technological breakthroughsany of these might take down many large businesses.
Companies cant build all possible events into their scenarios and should not spend too
much time on the low-probability ones. But they must be sure of surviving high-severity
outcomes, so such possibilities must be identifed and kept on a watch list.
Dont chop the tails off the distribution
In our experience, when people who are running businesses are presented with a range
of scenarios, they tend to choose one or two immediately to the right and left of reality
as they experience it at the time. They regard the extreme scenarios as a waste because
they wont happen or, if they do happen, all bets are off. By ignoring the outer scenarios
and spending their energy on moderate improvements or deteriorations from the present,
leaders leave themselves exposed to dramatic changesparticularly on the downside.
So strategists must include stretch scenarios while acknowledging their low probability.
Remember, risk and probability are not the same thing. Because the risk of an event is
equal to its probability times its magnitude, a low-probability event can still be disastrous
if its effects are large enough.
Dont discard scenarios too quickly
Sometimes the most interesting and insightful scenarios are the ones that initially seem
the most unlikely. This raises the question of how long companies should hold on to a
scenario. Scenarios ought to be treated dynamically. Depending on the level of detail they
aspire to, some might have a shelf life numbered only in months. Others may be kept and
reused over a period of years. To retain some relevance, a scenario must be a living thing.
Companies dont get a scenario rightthey keep it useful. Scenarios get better if revised
over time. It is useful to add one scenario for each that is discarded; a suite of roughly the
same number of scenarios should be maintained at all times.
Remember when to avoid scenarios altogether
Finally, bear in mind the one instance in which strategists will not want to use scenarios:
when uncertainty is so great that they cannot be built reliably at any level of detail.
2
Just
as scenarios help to avoid groupthink, they can also generate a groupthink of their own.
If everyone in an organization thinks the world can be categorized into four boxes on a
quadrant, it may convince itself that only four outcomes or kinds of outcomes can happen.
Thats very dangerous. Strategists should not think that they have all reasonable scenarios
when there are quite different possibilities out there.
2
For more, see the McKinsey Quarterlys interview with author Hugh Courtney, A fresh look at strategy under uncertainty,
at mckinseyquarterly.com.
36
Dont use a single variable
The future is multivariate, and there are elements strategists will miss. They should
therefore avoid scenarios that fall on a single spectrum (very good, good, not so good,
very bad). At least two variables should be used to construct scenariosand the variables
must not be dependent, or in reality there will be just one spectrum.
Some rules of thumb
Obviously, some general principles can be assembled from the points above: look for
events that are certain or nearly certain to happen; make sure scenarios cover a broad
range of outcomes; dont ignore extremes; dont discard scenarios too quickly just because
short-term reality appears to refute them and never be embarrassed by a seemingly too
pessimistic or optimistic scenario; understand when not enough is known to sketch out
a scenario; and so on. But there are some additional rules of thumb that I have found
particularly useful.
Always develop at least four scenarios
A scenario set should always contain at least four alternatives. Show three and people
always pick the middle one. Four forces them to discover which way they truly leanan
important input into the discussion. Two is always too few unless there is only one big
swing factor affecting the situation.
Technically, of course, many scenarios can be sketched out in almost any situation. All
possible combinations of just three uncertainties will create 27 scenarios. But many of
them will be impossible because the variables are rarely completely independent. Usually,
the possibilities can be boiled down to four or fve major possible futures.
Crunch the quadrants
Often people use a two-by-two matrix when presenting scenarios. But it is not routinely
the case that there are just two major variables. In developing scenarios, it would be
typical to identify three to fve critical uncertainties. How to resolve this tension? One
approach is to create multiple two-by-twos using all possible combinations of the four
or fve critical uncertainties. It will quickly become clear that some uncertainties are
highly correlated and so can be combinedand that others are not principal drivers of the
various scenarios. At minimum, this will allow for simplifcation. Sometimes, however,
it is possible to uncover a real insight when trying to describe a quadrant created by an
unusual combination of uncertainties.
3
There should always be a base or central case
This point goes back to the chief executive, mentioned above, who claimed that scenarios
were an abdication of responsibility. It is fne to put forward scenariosit is, in fact, the
3
I am grateful to Pherson Associates, specifcally Randy Pherson and Grace Scarborough, for bringing this technique to my
attention. I have found it extremely powerful in a number of client settings.

37
responsible thing to do. But those who must weigh scenarios and reach decisions based on
them expect and deserve to get a specifc point of view about the future. The scenario that
is highest in probability should always be identifed, and that ought to become the base
case. If that proves impossible, it should at least be feasible to fashion a central casebut
there must be crystal clarity about the degree of certainty attached to it, the alternatives,
and the resilience of any strategy to those alternatives.
Scenarios must have catchy names
The notion of attaching clever names to scenarios may well sound trivial. It is not. Unless
scenarios become a living part of an organization, they are useless. And if they do not have
snappy, memorable names, they will not enter the organizations lexicon. Use two to four
wordsno more. Plays on flm titles and historical events are recommended. Some names
that I have used, and that appear to have stuck, are Groundhog Day, the long chill,
perfect summer, end of an era, silver age, and Mexican spring.
Avoid long, descriptive titles. No one will remember Restrengthening world economy at
a lower level of overall growth. And avoid boring bull, bear, and base scenarios, even
though these are used by many stock analysts. If no snappy title seems to present itself
(assuming that someone creative is available), the scenario is probably too diffuse and may
contain elements of two different scenarios jammed together.
Learn from being totally wrong
Developing scenarios is an art rather than a science. People learn by experience. It is
useful to look back at old scenarios and ask what, in retrospect, they missed. What could
have been known at the time that would have made for better scenarios? Events will prove
that some scenarios were too narrow or that one was thrown out too soon. The more
comfortable an organization and its people are with mistakes and learning from them, the
less likely it is to be mistaken again.
Listen to contrary voices
This is a good corrective to groupthink. We tend to dismiss the mavericks. Scenarios are
there to make room for them. Maverick scenarios have the virtue of being surprising,
which makes people think. If a companys scenarios are all completely predictable
(conventionally good, conventionally bad, and somewhere in the middle), they are not
going to be valuable. The best scenarios are built on a new insighteither something
predetermined that others have missed or an unobvious but critical uncertainty.
On one occasion, when oil was at $120 a barrel, we presented a scenario with oil at $70.
Someone asked what would happen if oil dropped to $10 a barrel. We said that was
unnecessarily radical. But we probably should not have been so dismissive, as oil promptly
fell below $50 a barrel. We should have been more open to the possibility of this radical
price swingafter all, oil has been at $10 a barrel well within living memory. Scenarios
38
should not assume a short-term time series; they should go back as far as possible. If a
data series going back 300 years is available, you should consider using it (they do exist
for UK interest rates and UK government debt as a percentage of GDP and these long-term
data series have certainly informed current debates about the possible interest rates and
sustainable debt to GDP ratios). Most variables can only be supported by data going back
tens of yearsbut even this is much more instructive than the meager data often used and
helps broaden the range of possible outcomes.
Even modest environmental changes can have enormous impact
The best example of this principle is that specialist business models fail when the business
environment changes. I call this the saber-toothed tiger problem. The saber-toothed tiger
was a specialist killing machine, its big teeth perfectly evolved to capture large mammals.
When the environment changed and the large mammals became extinct, saber-toothed
tigers became extinct toothose large teeth were not as good for catching small, furry
mammals. By contrast, the shark is a generalist killing machineand so has remained
highly successful for hundreds of millions of years.
A specialist business model can suffer the fate of the saber-toothed tiger if the environment
changes. Many winning business models are highly specialized and precisely adapted
to the current business environment. Therefore no one should ever assume that todays
winners will be in an advantaged position in all possible futures (or even most of them).
Therefore, scenarios should be based on creative thinking about how predicted changes in
the business environment will alter the competitive landscape. If the environment changes
in a scenario but the competitors remain the same, that scenario may not be imaginative
enough.
None of the above is rocket science. Why, then, dont people routinely create robust sets
of scenarios, create contingency plans for each of them, watch to see which scenario
is emerging, and live by it? Scenarios are in fact harder than they lookharder to
conceptualize, harder to build, and uncomfortably rich in shortcomings. A good one takes
time to build, and so a whole set takes a correspondingly larger investment of time and
energy.
Scenarios will not provide all of the answers, but they help executives ask better questions
and prepare for the unexpected. And that makes them a very valuable tool indeed.
Charles Roxburgh is a director in McKinseys London offce. Copyright 2009 McKinsey & Company. All rights reserved.
Related articles

Strategic planning: Three
tips for 2009
Hidden faws in strategy
Making the most of
uncertainty
39
Hugh Courtneys book, 20/20 Foresight: Crafting Strategy in an
Uncertain World, was published the day before the terrorist attacks of
September 11, 2001. As the economist and former McKinsey associate
principal recalls, in the following weeks interviewers often asked him,
Does this change everything? Is this stuff still valid? The world is so
much more uncertain. Says Courtney, The honest answer then was
that the only thing that had changed was our perception of risks and
uncertainties that were always there. And its the same answer I give
today about the current global business and fnancial situation.
One of Courtneys contributions to the literature of strategy was a four-
part framework to help managers determine the level of uncertainty
surrounding strategic decisions. In level one, there is a clear, single view
of the future; in level two, a limited set of possible future outcomes, one
of which will occur; in level three, a range of possible future outcomes;
and in level four, a limitless range of possible future outcomes.
Courtney, an associate dean of executive programs and professor of the
practice of strategy at the University of Marylands Robert H. Smith
School of Business, discussed the relevance of this idea in a recent
interview with the Quarterly.
Although even the highest levels of uncertainty dont
prevent businesses from analyzing predicaments
rationally, says author Hugh Courtney, the fnancial crisis
has shown us the limits of our toolsand minds.
A fresh look
at strategy
under
uncertainty:
An interview
Strategy
This interview was
conducted by McKinsey
Quarterly editors.
The Quarterly: How do you evaluate the level of business
uncertainty today?
Hugh Courtney: The fnancial crisis has actually brought greater
clarity because it has forced us to recognize that we have a lot more
level three and level four situations than we would have admitted
a few months ago. They probably were there all along, yet the bias
was toward thinking that issues were more at level one and level two.
Specifcally, we have learned how interdependent our fnancial markets
are and how systemic failure in any important node of the network can
work very rapidly through the system and bring liquidity to a halt. So
our scenarios about the availability of capital around the world have
changed signifcantly.
Maybe the world and the uncertainties we face havent changed all that
much as a result of the fnancial crisis, but our perception of risks has.
That means there is a real opportunity to rethink the way we make
strategic decisions, the way we plan under uncertainty. We should
Hugh Courtney
Fast facts
Recipient of numerous MBA and executive teaching awards
Named one of fve Up and Comers in management
consulting, Consulting Magazine (December 2001)
Consults on strategic planning, decision making, and
competitive dynamics under uncertainty
Has served on multiple non proft boards
Enjoys what his children enjoy: professional and collegiate
athletics, hiking, and the beach

Career highlights
D&E Communications (2005present)
Chairman (2008)
University of Marylands Robert H. Smith
School of Business (2002)
Associate dean of executive programs (2008)
Professor of the practice of strategy (2007)

McKinsey & Company (1993-2002)
Associate principal (2000-2002)
Strategy practice senior engagement manager

(1998-2000)
Vital statistics
Born January 12, 1963, in Boston, Massachusetts
Married, with three children
Education
Graduated with BA in economics in 1985 from
Northwestern University
Earned PhD in economics in 1991 from the
Massachusetts Institute of Technology
41 A fresh look at strategy under uncertainty: An interview
realize that, across sectors, for most important decisions were actually
pretty far to the rightlevels three and fourin the uncertainty
spectrum.
The Quarterly: What does that mean in practice for managers?
Hugh Courtney: Level four situations are, by defnition, ones for
which you cant really bound the range of outcomes, because its
anybodys guess. Im sure weve all felt a little bit of that in the last few
months. So the question is, do you just have to wing it? Is that what
strategic decision making comes down to? I dont think thats true at
all, but level four does require a different mind-set.
From level one to level three, the presumption is that you can do some
bottom-up analysis. You can fgure out what the value drivers are
and do some market research and some competitive intelligence. All
this may not give you a precise forecast, but youll be able to bound
the outcomes somehow. Thats impossible in level four situations, by
defnition. Theres just stuff thats fundamentally unknowabletruly
an ambiguous world.
On the other hand, that doesnt mean you cant be rigorous in thinking
through strategic decisions in level four. It just requires you to work
backward from potential strategies to what you would have to believe
about the future for those strategies to succeed. The classic example
would be biotechearly-stage biotech investments have always faced
level four uncertainty, because youre playing with therapies with an
ultimate commercial viability that is unknown.
e x h i b i t
The four levels of residual uncertainty
True uncertainty
Not even a range of possible future
outcomes
Clear enough future
Single view of the future
Alternative futures
Limited set of possible future outcomes,
one of which will occur
A
B
C
Range of futures
Range of possible future outcomes
Level 1
Level 2
Level 3
Level 4
The Quarterly: How does that play out?
Hugh Courtney: You could ask, Whats the return on investment
of starting up a lab in this particular therapy? The answer would
be, Who knows? Honestly, no amount of analysis would allow
you to bound the ROI. But say you told me the following: Were
thinking about investing in a lab to work on a therapy. The labs
going to cost $10 million. Should we do it? Of course, I could say,
Well, I dont know. But I could also work backward from that $10
million investment and reply along these lines: Say you need a 15
percent return on that investment. I can develop a scenario about the
conditions needed to achieve thiswhat you would have to believe
about the probability of fnding a viable treatment, the amount of
time it would take to get to market, the physician uptake rate on
that treatment, the compliance rate of patients over time, what youd
be able to price it at, for how long, and how long youd have patent
protection. I could tell you all that. In fact, I could give you a range of
scenarios, all of which will give you that 15 percent return.
Now, the reason that approach would be useful is that even though
I cant do any bottom-up analysis, I can look at analogies. Theres
a whole history of drug development, and I can at least place those
scenarios within the range of other outcomes in the past. Then I could
tell you, for example, We know now that this project would have
to be the most successful drug launch in history to earn the return
you want on that $10 million. I cant say whether its going to play
out that way, but are you willing to roll the dice given those odds?
Alternatively, Hey, it only has to be as successful as the median drug-
discovery process.
In other words, you can think about a level four problem in a very
structured way. Its just that your mind-set has to change from a
bottom-up analysis based on the value drivers to one based on what
we know from similar situations in the past. You dont have to wing it.
The Quarterly: Lets say Im a strategist for a fnancial-services
company. How should I think about todays uncertainty?
Hugh Courtney: This is a really interesting time because it provides
unprecedented opportunities for the survivors. I think the fundamental
strategic issues are whether there will continue to be benefts of scope
and scale in fnancial services and whether there will be a big pure-
play investment-banking industry in the future.
We learned very well with GlassSteagall
1
reform that the benefts of
scope and scale are highly dependent on regulatory structurethat
1
The Glass-Steagall Act of 1933 established the Federal Deposit Insurance Corporation (FDIC)
in the United States and separated investment and commercial banking activities. The act was
repealed in 1999.
is, what youre allowed to do with that scope and scale. For example,
regulations will infuence to what extent scope and scale will give you
preferential access to low-cost capital, as well as how much youre
able to leverage and what you can and cant do to hedge risks. And
thats why even the healthiest fnancial-services players today face
tough strategic choices: they have the opportunity to make bold scope-
and scale-building plays, yet the payoffs are highly reliant on future
regulatory decisions that are up in the air.
The Quarterly: So what level of uncertainty does this represent?
Hugh Courtney: I imagine most of the leaders of the fnancial
powerhouses understand the possible regulatory alternatives, and
theyre well enough connected to people in Washington to see how
this could play out. Potentially, it could be level two. There really are
discrete alternatives, and theres usually only a number of fairly well-
defned ways to regulate any market environment. If you layer on top
of this the fact that our political process tends to even out the extremes,
maybe the range of alternatives is actually even narrower. So these are
the sorts of things that can be bounded, and multiple scenarios can be
run and quantifed. The hard part for the decision makers is that even
if you can defne the scenarios, they have quite different implications
for strategy. Still, the example illustrates why applying this kind of
disciplined thinking is extremely helpful when you make such bets in
uncertain times.
The Quarterly: What advice would you give to a chief strategy
offcer today?
Hugh Courtney: I would start with, What were you doing in
strategic planning before the fnancial crisis hit? and How well
do you think it worked? As I said, whats changed is largely our
perception of uncertainty. Most CSOs would reply, Well, we had
a pretty standard strategic-planning process. We did some industry
analysis and market research and tried to do some long-term
discounted cash fow on our opportunities. It was very fnancially
driven and we felt it worked pretty well. In the end, though, you
would probably fnd that they were treating a lot of level three and four
issues like level one and two issues and relying on the wrong tool kit.
So I would start with scenario-planning techniqueseven though
scenario planning has been around for decades, its still a niche tool in
strategic-development and -planning efforts. The CSO and I would also
talk about using analogies better. The basis of the analogy doesnt have
to be the exact thing youve done in the past, but it should be a similar
space, geography, or basic business model that you can learn from.
Many people today are asking what might be analogous situations,
such as the Great Depression or the 1997 Asian fnancial crisis, and I
really understand why they are focused on them: its a classic example
of using level four reasoning when its hard to use any other.
Finally, this is a good time to rethink your planning process. Have
you been doing strategic planning on an annual basis as a paper-
pushing exercise? That will have to change. In the months to come,
youre going to have to make decisions very quickly on fundamental
opportunities that may drive your earnings performance for the
next decade or more, and youve got to be prepared to make these
decisions in real time. That requires a continuous focus on market and
competitive intelligence and far more frequent conversationsdaily,
if necessaryamong the top team about the current situation. Senior
executives already may be in closer contact because of the emergency
they face, but that doesnt necessarily imply that they have the
raw material and the structure to work through strategic decisions
systematically. These daily conversations have to move beyond
getting through that days crisis to more fundamental strategic issues
as well, because the decisions made today may open up or close off
opportunities for months and years to come.
The Quarterly: Your book discusses the shaper and adapter
models. How should strategists think about shaping and adapting
in these times?
Hugh Courtney: That depends on how prepared or fortunate
you were going into this downturn. No one player can shape the
fundamental uncertainties that are driving global capital markets.
Interdependent players all over the world are making decisions. No one
playernot even a Warren Buffettcan say, You know, I feel great
about things, and change the dynamics all that much. So in some
sense, everyone has to adapt to that macro uncertainty.
When it comes to fundamental strategic decisions, the paradox is that
for a lot of companies in the most uncertain environments, theres
actually very little uncertainty about what theyre going to do. The
situation is very clear because of the condition of their balance sheets.
They really have to hunker down. They just dont have the degrees of
freedom to think about fundamental changes in their strategy.
On the other hand, there are the fortunate few that have very healthy
balance sheets, arent so dependent on fnancing today, and dont hold
a lot of bad assets. They have a real interest in shaping opportunities.
Again, they cannot shape the macro environment; they must adapt
to that. However, they can fundamentally reshape their industry
landscapes with bold M&A plays, R&D that others cant fnance, and
entry into new markets. They can make bold moves that may shape
the way their markets and industries play out for many years to come
by fundamentally changing the competitive dynamics or product
positioning. They do have degrees of freedom and thus the opportunity
to be successful shapers.
The Quarterly: Who are these fortunate few?
Hugh Courtney: They tend to be companies with business models
that generate a lot of cash and dont have much debt. That would
include a lot of high-tech companies and service businesses in general,
which tend to scale up through people rather than through $100
million plants. Similarly, some businesses in the energy, utilities, and
telecom sectors rely on fully depreciated assets generating a lot of
operating cash. So the fortunate companies are in sectors that have real
cash cow businesses, even if these companies cant completely escape
the proftability and growth challenges that will be diffcult for any
company to avoid in the near future.
The Quarterly: Would your message be the same for companies
in emerging markets like India and China?
Hugh Courtney: Yes, and in many cases the shaping opportunities
are even greater. The fortunate companies are those that have healthy
balance sheets and dont need reliable, cheap fnancing right now,
because such a reliance would put the brakes on a lot of current
entrepreneurial efforts, particularly in countries like India and China.
Some of the larger incumbentsthe Tatas of the worldmay have
profound shaping opportunities in their home markets because a lot
of global companies are going to retrench and pull back a little. These
trends are at work in economies all around the globe, and companies
with healthy balance sheets, the right capabilities, and a tolerance for
risk can put together positions that could drive competitive advantage
for years.
The Quarterly: How has your thinking changed since you wrote
20/20 Foresight?
Hugh Courtney: The fnancial crisis and 9/11 are wake-up calls to
think about better management of risk and uncertainty. I fnd myself
these days taking uncertainly more seriously. Remember, in the book I
wrote that everyone should take uncertainty seriously, but day to day I
fall into standard patterns that behavioral scientists have described
for example, I tend to have too much confdence in my ability to predict
the future.
In the aftermath of the fnancial crisis, Ive been thinking a lot about
how these fundamental human cognitive biases infuence everything we
do in strategy development. We actually know more about the world
today than we did a few months ago, because theres information in
the meltdown. But the message behind that information is really, You
fools, remember that youre human. Remember the biases that lead us
to be overconfdent in our ability to forecast the future. Remember that
the most important decisions for most companies will truly be level
three and, many times, level four decisions. Our standard strategic-
planning tool kitsthe ones that we are most comfortable with and
that we learn in MBA programsdont do a really good job for that.
So we ought to pay attention to this wake-up call. Embrace
uncertainty. Get to know it. In uncertainty lies great opportunity. If
you dont try to understand whats separating the known from the
unknown from the unknowable, youre really missing out. Youre just
playing roulette with big moneyusually other peoples money. It
behooves us to take uncertainty seriously and to fundamentally rethink
the way we do strategic thinking and planning.
Copyright 2009
McKinsey & Company.
We welcome your
comments on this article.
Please send them to
quarterly_comments@
mckinsey.com.
J U N E 2 0 0 9
Rebuilding corporate
reputations
A perfect storm has hit the standing of big business. Companies must
step up their reputation-management efforts in response.
Sheila Bonini, David Court, and Alberto Marchi
48
As governments respond to the fnancial crisis and its reverberations in the real economy,
a companys reputation has begun to matter more now than it has in decades. Companies and
industries with reputation problems are more likely to incur the wrath of legislators, regulators,
and the public. Whats more, the credibility of the private sector will infuence its ability to weigh
in on contentious issues, such as protectionism, that have serious implications for the global
economys future.
Senior executives are acutely aware of how serious todays reputational challenge is. Most
recognize the perception that some companies in certain sectors (particularly fnancial services)
have violated their social contract with consumers, shareholders, regulators, and taxpayers. They
also know that this perception seems to have spilled over to business more broadly. In a March
2009 McKinsey Quarterly survey of senior executives around the world, 85 and 72 percent
of them, respectively, said that public trust in business and commitment to free markets had
deteriorated.
1
According to the 2009 Edelman Trust Barometer, those executives are reading
the public mind correctly: 62 percent of respondents, across 20 countries, say that they trust
corporations less now than they did a year ago.
The breadth and depth of todays reputational challenge is a consequence not just of the
speed, severity, and unexpectedness of recent economic events but also of underlying shifts in
the reputation environment that have been under way for some time. Those changes include
the growing importance of Web-based participatory media, the increasing signifcance
of nongovernmental organizations (NGOs) and other third parties, and declining trust in
advertising. Together, these forces are promoting wider, faster scrutiny of companies and
rendering traditional public-relations tools less effective in addressing reputational challenges.
Now more than ever, it will be actionnot spinthat builds strong reputations. Organizations
need to enhance their listening skills so that they are suffciently aware of emerging issues;
to reinvigorate their understanding of, and relationships with, critical stakeholders; and
to go beyond traditional PR by activating a network of supporters who can infuence key
constituencies. Doing so effectively means stepping up both the sophistication and the internal
coordination of reputation efforts. Some companies, for example, not only use cutting-edge
attitudinal-segmentation techniques to better understand the concerns of stakeholders but
also mobilize cross-functional teams to gather intelligence and respond quickly to far-fung
reputational threats.
One key to cutting through organizational barriers that might impede such efforts is committed
senior leadership, including leadership from CEOs, who have an opportunity in todays charged
environment to differentiate their companies by demonstrating real statesmanship. The stakes
demand it; an energized public will expect nothing else. At a moment when capitalism seems
fat on its back, CEOs have an obligation to bolster the reputations of their companies and of free
markets.
A rapidly evolving reputation environment
The fnancial crisis has underscored just how ill-equipped companies can be to deal with two
important changes in the reputation environment. First, the infuence of indirect stakeholders
1
See Economic Conditions Snapshot, March 2009: McKinsey Global Survey Results, mckinseyquarterly.com, March 2009.
such as NGOs, community activists, and online networkshas grown enormously. The number
of NGOs accredited by the United Nations, for instance, has grown to more than 4,000, from
less than 1,000 in the early 1980s. These proliferating indirect stakeholders have tasked business
with a broader set of expectations, such as making globalization more humane and combating
climate change, obesity, human-rights abuses, or HIV.
Second, the proliferation of media technologies and outlets, along with the emergence of new
Web-based platforms, has given individuals and organizations new tools they use to subject
companies to greater and faster scrutiny. This communications revolution also means that
certain issues (such as poor labor conditions) that might be acceptable in one region can be
picked up by citizen journalists or bloggers and generate outrage in another.
As a result, what formerly were operational risks resulting from failed or inadequate processes,
people, or systems now often manifest themselves as reputational risks whose costs far exceed
those of the original missteps. In banking, for example, data privacy has become a reputational
issue. In pharmaceutical clinical trials, Mercks experience with Vioxx showed that anything less
than full transparency can lead to disaster. And as risk-management problems in the fnancial
sector have generated astronomical losses that taxpayers are helping bear, its little wonder that
the reputational fallout has been enormous.
An outmoded approach to reputation management
In this dispersed and multifaceted environment, companies must collect information about
reputational threats across the organization, analyze that information in sophisticated ways,
and address problems by taking action to mitigate them. That can involve developing alliances
with new kinds of partners and coordinating responses from a number of parties, including
governments, civil-society groups, and consumers. All this requires signifcant coordination and
an ability to act quickly.
Many companies, though, rely primarily on small, central corporate-affairs departments that
cant monitor or examine diverse reputational threats with suffcient sophistication. Moreover,
traditional PR spin cant deal with many NGO concerns, which must often be addressed by
changing business operations and conducting two-way conversations. Managers of business
units have a better position for spotting potential challenges but often fail to recognize their
reputational signifcance. Internal communication about them may be inhibited by the absence
of consistent methodologies for tracking and quantifying reputational risk. Accountability for
managing problems is often blurred.
As a result, responses to reputational issues can be short term, ad hoc, and defensivea poor
combination today given the intensity of public concern. And therein lies a problem that
companies must solve quickly: even as reputational challenges boost the importance of good
PR, companies will struggle if they rely on PR alone, with little insight into the root causes
of or the facts behind their reputational problems.
A better, more integrated response
A logical starting point for companies seeking to raise their game is to put in place an effective
early-warning system to make executives aware of reputational problems quickly. In our
experience, most companies are quite good at tracking press mentions, and many are beginning
49
50
Stanley Greenberg and Howard Paster are political consultants and
public-relations experts with a long history of advising companies
and individuals, including former US president Bill Clinton. Paster
also formerly served as chairman and CEO of Hill & Knowlton, a
PR firm owned by the WPP Group. The conversation that follows,
in which the two reputation gurus reflect on the challenges facing
business leaders and the steps they should take to rebuild trust, is
a compilation of interviews that McKinseys Sheila Bonini and Allen
Webb conducted separately with Greenberg and Paster in March
2009.
The Quarterly: The reputation of big business has waxed and
waned over the years. Do you see anything exceptional in attitudes
toward business today?
Stanley Greenberg: Whats special now is that corporate behavior
is seen as being central to the most severe economic crisis since
the Depression. This is being identified as a crisis produced by bad
decisions and irresponsible behavior. That makes reputation issues
more dramatic than in any prior period.
Howard Paster: Weve also got a larger set of reputation issues
here: trust, confidence, wondering whether unfettered capitalism is
a problem.
The Quarterly: How can companies dig out?
Stanley Greenberg: Responsibility is critical. I dont mean
assigning responsibility, but people in positions of responsibility
assuming responsibility. There is probably nothing more important
to get right than conveying that the leaders of companies recognize
this is a special moment.
I also think this is uniquely a time when the answer to the reputation
problem lies less in what you are doing externally and more in what
kind of company you runthe way you deal with your employees
and consumers, the behavior and compensation of leaders. I dont
think you address this problem by doing more work in food banks
or in neighborhoods; I think this is really about business practices.
If youre a bank, people think you have walked away from your
essential functions. So you have to highlight how you are resuming
business and expanding lending, if you are.
Howard Paster: The first thing you have to do if youre in financial
services is explain to people that you werent part of the problem,
assuming you werent. You need to come up with specific ways
to put distance between you and the bad guys. For example, the
public face of a company is a big deal. Companies in trouble are
wise to change their chief executives.
Youve also got to announce, all the time, how youre doing things
differently. You have to devise ways of reiterating this again and
againpreaching and living integrity internally, having codes of
conduct, having the right kinds of staff briefings, making integrity a
basic premise of your operation, building it into your business. At a
time when you have less money for philanthropy, for environmental
initiatives, or for your employees, youd better run a place with a lot
of integrity.
The Quarterly: How important are symbolic actions, such as
Goldman Sachss recent announcement that employees will stay at a
lower-cost hotel when they go to New York?
Stanley Greenberg: I think it is a big deal. It may look like
symbolism, but it is an important new tone. Executives have
seemed tone deaf.
The Quarterly: What else can help?
Howard Paster: When a company gets into trouble, we always
say, Who is there that you can bring in, whose reputation is such
that he or she, by virtue of being your independent auditor or
your independent investigator, can become part of the cleansing
processidentify problems, be believed by the media, authenticate
changed behavior? People like to use former attorneys general
or someone like former senator Warren Rudman, a man of great
probity: strong willed, but God hes honest and hell tell you what he
thinks. Thats worth a lot.
The Quarterly: One reason reputation is important is that it will
influence regulations and policies. How should companies approach
this debate?
Stanley Greenberg: We are going to move to re-regulating a
whole range of markets as a result of all this. I think companies,
understanding that the public views them as having produced a
global crisis of unheard-of proportions, need to be thinking about
how they reenter the debate. The perception I see among many
companies is that government is overreaching. But I do not think
pushing back is the best way to reenter the public discussion about
the proper balance of regulation. Right now, I assume CEOs are
not a very legitimate voice on how to regulate properly. One of the
greater challenges will be how business gets the right voice for a
momentous debate. I think responsibility is the critical piece. People
are looking for responsibility to be a much stronger value on an
individual, corporate, and political level. The companies that get this,
that seem to be part of this, are in a much better position to have a
voice in re-regulation.
Sheila Bonini is a consultant in McKinseys Silicon Valley offce,
and Allen Webb is a member of The McKinsey Quarterlys board of editors.
Assuming
responsibility
51
to monitor the multitude of Web-based voices and NGOs, whose power is beginning to rival the
mainstream medias. However, doing these things effectively, while an important prerequisite for
stepping up engagement with stakeholders, isnt the toughest task facing organizations.
Far more of a challenge is preparing to meet serious reputational threats, whose potential
frequency and cost have risen dramatically given the greater likelihood that stakeholders
including regulators and legislatorswill lash out in an atmosphere thats become less hospitable
to business. These threats might take a variety of forms: issues related to a companys business
performance, like those that fnancial companies have recently experienced (see sidebar,
Assuming responsibility); unexpected shocks along the lines of Johnson & Johnsons Tylenol
scare, more than two decades ago; opposition to business moves, such as expanding operations;
or long-standing, sector-specifc issues, for instance climate change (industrials and oil and gas),
obesity (the food and beverage industry), hidden fees (telecom providers), e-waste (high tech),
and worker safety (mining).
To prepare for and respond to these threats, our experience suggests that companies should
emphasize three priorities. First, they need to assemble enough factsmost important, perhaps,
a rich understanding of key stakeholders, including consumersand not only the product
preferences but also the political attitudes of consumer groups. Second, companies should focus
on the actions that matter most to stakeholders, something that may call for an exaggerated
degree of transparency about corporate priorities or operations. Third, they must try to infuence
stakeholders through techniques that go beyond traditional PR approaches, with an emphasis on
two-way dialogue. Underlying these priorities is a willingness to participate in the public debate
more actively than many companies have in the past. Instead of allowing single-issue interest
groups to control the conversation, companies should insist on a more complete dialogue that
raises awareness of the diffcult trade-offs they face.
Understanding stakeholders and their concerns
Companies should frst develop a deeper understanding of the reputational issues that matter
to their stakeholders and of the degree to which their products, services, operations, supply
chains, and other activities affect those issues. A company trying to improve its environmental
reputation, for example, needs to document, catalog, and assess its sustainability efforts and
then to benchmark them against those of its competitors and industry standards. The facts
should be presented objectively and, if possible, quantitativelyfor example, the amount of
carbon emitted or water used. Quantitative measurements promote effective comparisons and
help companies avoid ignoring potential issues or performance gaps.
Such an analysis may lead a company to conclude that it has a good story that should be told
more vigorouslyor that it should refrain from doing so until it takes real action. The analysis
also is the starting point for an objective quantifcation of reputational risks. The company can
prioritize them and the measures needed to keep them at bay by assessing the probability and
fnancial cost of potential reputational events, such as consumer boycotts or the forced closure of
operations.
Reputations are built on perceptions, however, so issue analysis isnt enough. Companies must
also know if they are meeting the expectations of key stakeholdersthose in the best position
to infuence sales and growth. To identify these centers of infuence, companies should cast a
52
wide net, scrutinizing not just traditional stakeholders (consumers, employees, shareholders,
and regulators) but also indirect ones, such as NGOs and the media, that help shape attitudes.
Even for companies that dont deal directly with consumers, its important to understand public
opinion. People have unprecedented access to information now and may therefore concern
themselves with a surprisingly wide array of issues, potentially providing the impetus for
regulatory or legislative action.
Each kind of stakeholder has unique perceptions and concerns. Shareholders might ask if
reputational issues will affect a companys long-term growth prospects. Regulators could worry
that the public thinks they should curb the company. The media might wonder if it could be an
example of how business exploits society. There are different ways of identifying the perceptions
of each kind of stakeholder and their root causes (Exhibit 1). A detailed press analysis can help
companies to understand the positions of columnists and editors on key issues. Interviews
with regulators can clarify their concerns. Focus groups and market research are important for
understanding consumers and the wider public.
If consumer research is required, companies must understand that an analysis of how different
consumers feel about them differs from typical segmentations: one for reputation management
Exhibit 1
Understanding the
stakeholders
Web 2000
Corporate reputation
Exhibit 1 of 2
Glance: A company can employ methods specic to each type of stakeholder in seeking to understand its
position on reputational issues.
Consumers and
partners
Media, including
Internet, newspapers,
TV
Shareholders,
analysts, investors
Regulators
Key issues Avoiding purchases, because
of negative perceptions of
company
Portraying big business
issues in a negative light
Lacking the in-depth
reporting required for a
balanced view of the
issue
Effect on share prices
Changing investments
Shaping policy and
regulation
Monitoring impact on
consumers,
environment, and
society
Key questions
asked by
stakeholders
Limited; if any, probably
through investment
conferences
Limited, usually through
telephone discussions with
investor relations unit
Multiple in-depth meet-
ings with executives at all
senior leadership levels
Follow-up conversations,
if necessary, with investor
relations unit
Occasional meetings,
calls with investor
relations unit
Semiannual or annual
senior-management
meetings
Civil societyeg,
activist groups,
nongovernmental
organizations (NGOs),
labor unions

Advocating
environmental, social,
governance, and
economic standards
Actions
company
can take
Past nancials, consensus
estimates, trading informa-
tion, implied valuation
Web site, press releases,
management press,
sell-side analyst calls and
reports, industry reports
Past operations and unit-
level information, man-
agements future strategy
and forecasts, industry
outlook, managements
background
Detailed follow-up
information from company
Quarterly updates on
performance, signicant
changes in outlook
Quarterly updates on
performance, signicant
changes in outlook
calls with investor
relations unit
senior-management
meetings
Questions
company
should ask
Limited; if any, probably
through investment
conferences
Limited, usually through
telephone discussions with
investor relations unit
Multiple in-depth meet-
ings with executives at all
senior leadership levels
Follow-up conversations,
if necessary, with investor
relations unit
calls with investor
relations unit
senior-management
meetings
calls with investor
relations unit
senior-management
meetings
A company can employ methods specic to each type of stakeholder in seeking to understand its position on reputational issues.

Understanding the stakeholders
53
resembles a dissection of voters in a political campaign rather than a parsing of customers who
prefer different types of products or services. There might, for example, be a group of consumers
who care deeply about social issues and will weigh in aggressively on regulatory ones affecting a
companys operations. Others, such as swing voters, might be undecided about whether, or how,
to become involved. Some could be uninterested and unlikely to take action. Still others may
be so anti- or probusiness that their positions are set in stone. One consumer company facing
regulatory challenges used this type of social attitudinal segmentation to analyze consumers
(Exhibit 2). After identifying people who were both infuential and open-minded, the company
focused on addressing their needs, and the publics attitudes toward it improved.
Transparency and action
Reputations are built on a foundation not only of communications but also of deeds: stakeholders
can see through PR that isnt supported by real and consistent business activity. Consumers,
our research indicates, feel that companies rely too much on lobbying and PR unsupported by
action. They also fault companies for not sharing enough information about critical business
issuesfor manufacturers, say, the content of their products, their manufacturing processes, and
their treatment of production employees. Transparency in such matters is crucial. Sometimes
it highlights a mismatch between consumer expectations and a companys performance and
therefore calls for action. In other cases, transparency can convince key stakeholders that the
company is headed in the right direction.
After the director of the US Food and Drug Administration voiced reservations about the side
effects of the high-cholesterol treatment Crestor, for example, AstraZeneca not only placed ads
in the national press to present its case but also took the unusual step of providing raw clinical-
trial data on its Web site, allowing completely independent researchers to draw their own
conclusions. This was a high-risk strategy, since its always possible to draw different statistical
inferences from the same data. But the strategy reestablished public trust and stabilized
Crestors market share.
Exhibit 2
Whom to target
Segment 7
Young, uninvolved; have
not yet formed opinions
Segment 6
Distrustful of
business; struggling
to pay bills
Segment 5
Angry about industry;
skeptical of big
business
Segment 4
Knowledgeable; concerned
about effect of company
Segment 1
Believers in the system,
its companies
Segment 2
Moms who
value choice for
their families
Segment 3
Educated, well-off;
generally comfortable
with company
Attitudinal segments
For disguised European consumer company
% of population
Perception of company by segments
Size of the bubble = segment size
16
11
13
14
18
13
15
Positive
Negative
P
e
r
c
e
p
t
i
o
n

o
f

c
o
m
p
a
n
y
Low
Reinforce
strengths
Build
relationship
Track over time
Level of participation/inuence
High
1
4
6
3
7
5
2
54
Consider also the efforts of the US plastics industry to overcome a consumer and regulatory
backlash, in the late 1980s, over plastic packagings environmental impact. The CEOs of leading
companies joined forces to reframe the public debate not just through an award-winning ad
campaign illustrating positive applications of plastics (in child safety, for example) but also by
committing the industry to recycling and thus to solving environmental problems. The industry
could do so credibly because it undertook real actions, such as spending $1.2 billion on recycling
research and developing a standardized plastics-coding system.
Such actions need not take place only in response to reputational concerns; at other times, they
help build goodwill that may provide some degree of cover against future bad news. A willingness
to tackle climate change has helped companies like Toyota Motor and GE, for example, build
strong reputations that are holding up better than those of many other major automotive and
fnancial-services players. Sometimes, reputation-oriented actions may even have a direct impact
on sales. In 2008, for instance, Best Buy began inviting customers to bring their old electronics
into its stores for recycling. The program has not only generated positive press and helped
position the company as an environmental leader but is also increasing foot traffc in stores.
Engaging a broad group of influencers
Formal marketing and PR do play an important role in managing the reputation of a company,
but when it responds to serious threats it must use many other means of spreading positive
messages about its activities quickly (Exhibit 3). In general, credible third parties speaking for
Exhibit 3
No time to waste
Purpose
To ensure opportunity to refute
critics and deliver messages in daily
news cycles
Media professionals war room,
responsible for monitoring, responding
to news
No attack left unanswered;
respond to every reporter
Examples Desired outcomes
War room
To deliver messages through
low-cost, high-trust channels
Speeches, events, press conferences Regularly create new stories showing
company in favorable light
Free media
To deliver messages with maximum
control of message and targeting
Television, print ads, brochures,
Web sites, mailings
Ensure everyone hears, sees,
reads message
Paid media
To develop relationships with broad
set of stakeholders; listen and deliver
messages to them
Meetings with politicians, organizations
(eg, unions), media, other stakeholders
Wide network of inuential
supporters; better understanding
of detractors
Networking
To reinforce messages through
charitable contributions
Timberlands charitable focus on
environmental causes
Positive associations from
working on good causes
Giving
To reinforce messages and reduce
reputational risks through activities
within business
Starbuckss fair tradecertied coffee;
Nikes supplier policies
Seamless integration between
companys actions and reputational
consequences
Operations
To gain credibility by working
with others to solve industry-wide
reputation issues
Labor certication standards in
textile industry
More friends to help in shared
reputation battles
Partnerships
To use high-credibility people
to reinforce strategic messages
Placing prominent people on board,
in executive positions
People with star power speaking
up for the company
Surrogates
To leverage energy of current
supporters
Bumper stickers, blogs, interactive
Web sites
Support for company is highly visible Grassroots
Using a number of communication channels, beyond the typical public-relations approach, can boost awareness of a companys activities effectively.
55
the company can boost its reputation more effectively than its own PR or marketing department.
Leveraging existing grassroots supportthrough blogs, bumper stickers, and interactive Web
sites, for exampleis one method. Another is to have people with high standing reinforce key
strategic messages. Partnerships between the company and NGOs can be important not only
because of their credibility but also because they can alert it to performance gaps early in the
game. A network of positive relationships with credible third parties (such as journalists and
NGOs) can also help the company get out its side of the story when crises do hit.
One company worried about what it saw as the dangerous inaccuracy of its portrayal in the press
targeted opinion leaders with concise facts to dispel misunderstandings and gave regulators
a scientifc paper outlining the possible negative consequences of proposed regulations. A
broader communication program describing recent and forthcoming changes in the companys
business practices was released to the general public. This approach was effective, but even more
nuanced forms of impact are possible: infuencing specifc bloggers, using company blogs to start
conversations with consumers (a tactic Cisco, HP, and Intel, among others, use), and reaching
scientists through research discussion boards.
Increasingly, two-way dialogue is critical. Consider, for example, Chevrons Will you join us?
campaign, which addresses many of the oil industrys most diffcult questions, such as the
developing worlds energy needs, the role of renewables, environmental protection, and the
problems that will get worse if we go on using oil as we do now. The campaign not only embodies
a new level of openness about the industrys challenges but also asks the public to join the
conversation on a Web site with a moderated discussion board and interactive tools providing
information about conserving energy.
In this more complex world of infuence strategy, no single kind of approach is likely
to be suffcient to deal with fast-moving situations. Companies must instead initiate a
multidisciplinary, cross-functional effort that can quickly identify reputational issues and plant
responses in broader strategy, operations, and communications. The groups involved might
include regulatory affairs, the general counsel, PR or corporate communications, marketing,
corporate social responsibility, and investor relations.
To achieve the necessary coordination, a senior executive should be accountable for such efforts.
A strong understanding of customers and marketing might make the CMO appropriate to play
this role.
2
But its the CEO who must lead a companys overall reputation strategy, ideally with
the support of a board committee focused on it. This may seem like a lot of frepower, but in
todays climate, with reputational issues threatening both shareholders and a companys ability
to achieve broader goals, that degree of high-level attention and integration is essential.
Sheila Bonini is a consultant in McKinseys Silicon Valley offce, David Court is a director in the Dallas offce, and
Alberto Marchi is a principal in the Milan offce. Copyright 2009 McKinsey & Company.
Related articles

When social issues
become strategic
The trust gap
between consumers
and corporations
Valuing corporate
social responsibility:
McKinsey Global
Survey Results
CEOs as public
leaders: A McKinsey
Survey
2
See David Court, The evolving role of the CMO, mckinseyquarterly.com, August 2007.
Michele Zanini
Major crises and downturns often pro-
duce shakeouts that redefine industry
structures. However, these crises do not
fundamentally change an underlying
structural trend: the increasing inequality
in the size and performance of large
companies. Indeed, a financial crisisfor
example, the one that erupted in 2008
is likely to accelerate this intriguing long-
term tendency.
The past decade has seen the rise of many
mega-institutionscompanies of
unprecedented scale and scopethat have
steadily pulled away from their smaller
competitors.
1
What has received less
attention is the striking degree of inequality
in the size and performance of even the
mega-institutions themselves. Plotting the
distribution of net income among the
global top 150 corporations in 2005, for
example, doesnt yield a common bell
curve, which would imply a relatively even
spread of values around a mean. The
result instead is a power curve, which,
unlike normal distributions, implies
that most companies are below average.
Such a curve is characterized by a short
head, comprising a small set of companies
with extremely large incomes, and drops
off quickly to a long tail of companies
with significantly smaller incomes. This
pattern, similar to those illustrating the
distribution of wealth among ultrarich indi-
viduals, is described by a mathematical
relationship called a power law.
2
The
relationship is simple: a variable (for
example, net income) is a function of
another variable (for example, rank by
net income) with an exponent (for example,
rank raised to a power).
Exhibit 1 shows the top 30 US banks and
savings institutions in June 1994, 2007,
and 2008, measured by their domestic
deposits (the 2008 shares of different
institutions were adjusted to reflect the
surge of banking M&A in the autumn
of 2008). The exhibit shows that inequality
has been increasing from 1994 (when
the number-ten bank was roughly 30 per-
cent of the size of the largest one) to
2008 (when it was only 10 percent as large
as the first-ranked institution). It also
shows how in 2008, the financial crisis
accelerated the growth of the top five
compared with the other banks in the top
ten as the largest financial institutions took
advantage of their relatively healthy balance
Using power curves
to assess industry dynamics
Using power curves to assess industry dynamics 57
sheets and absorbed banks
in the next tier. Regulation could put a
damper on this crisis-driven accelera-
tion of inequality, but power curve dynam-
ics suggest that it will not reverse the
trend. Indeed, we found long-term patterns
of increasing inequality in size and per-
formance in a variety of industries and mar-
kets when we used metrics such as
market value, revenues, income, and assets
to plot the size of companies by rank.
Our analysis suggests that an industrys
degree of openness and competitive
intensity is an important determinant of
its power curve dynamics. You would
expect a bigger number of competitors and
consumer choices to flatten the curve,
but in fact the larger the system, the larger
the gap between the number-one and
the median spot. As Exhibit 1 shows, after
the liberalization of US interstate bank-
ing, in 1994, deposits grew significantly
faster in the top-ranking banks than in
the lower-ranking ones, creating a steeper
power curve. Greater openness may
create a more level playing field at first, but
progressively greater differentiation and
consolidation tend to occur over time, as
they did when the United States liber-
alized its telecom market.
Power curves are also promoted by intan-
gible assetstalent, networks, brands,
and intellectual propertybecause they can
drive increasing returns to scale, gener-
ate economies of scope, and help differen-
tiate value propositions. Exhibit 2 shows
a significant degree of inequality, across the
board, in the size and performance
of companies in a number of sectors we
researched. But the more labor- or capital-
intensive sectors, such as chemicals
and machinery, have flatter curves than
i
Auiusreu ro ielecr acquisirions iom |une ro Ocr zoo.
Souice: IDIC: NcKinsey analysis
0
10
20
30
40
50
60
70
80
90
100
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
June 1994
June 2007
June 2008
1
Rank by banking deposits
measure/subtitle
r x n i v i 1 i
Increasing inequality in banking
Top 30 US commercial banks and savings institutions by total domestic deposits; index: largest company = 100
intangible-rich ones, such as software
and biotech.
The fact that industry structures and
outcomes appear to be distributed around
natural values opens up an intriguing
new field of research into the strategic
implications. Notably, the extreme out-
comes that characterize power curves sug-
gest that strategic thrusts rather than
incremental strategies are required to
improve a companys position significantly.
Consider the retail mutual-fund industry,
for example. The major players sitting atop
this power curve (Exhibit 3) have oppor-
tunities to extend their lead over smaller
players by exploiting network effects,
such as cross-selling individual retirement
accounts (IRAs), to a large installed
base of 401(k) plan holders as they roll over
their assets. The financial crisis of 2008
may well boost this opportunity further as
weakened financial institutions consider
placing their asset-management units on
the block to raise capital.
When executives set strategy, power
curves can be a useful diagnostic tool for
understanding an industrys structural
dynamics. In particular, there may well
be commonalities across sectors in the
way these curves evolve, and that might
make it possible to gain better insights
based on the experience of other
industriesinto an industrys evolution.
As the importance of intangible assets
increases across sectors, for example,
will power curves in media and insurance
resemble the currently much steeper
ones found in todays intangible-rich sec-
tors such as software and biotech?
Power curves could also benchmark an
industrys performance. Curves for
specific industries evolve over many years,
so the appearance of large deviations
from a more recent norm can indicate
exceptional performance, on one hand,
or instability in the market, on the other.
Unlike the laws of physics, power curves
arent immutable. But their ubiquity
and consistency suggest that companies
Souice: GloLal Vanrage: NcKinsey analysis
100
90
80
70
60
50
40
30
20
10
0
2 1 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Distribution of market values, 2006; index: company with highest market value in each sector = 100
Rank by market value
Biotech
Insurance
Software
Machinery
Chemicals
Selected
industries
measure/subtitle
r x n i v i 1 z
Sector variations
Using power curves to assess industry dynamics 59
are generally competing not only against
one another but also against an indus-
try structure that becomes progressively
more unequal. For most companies,
this possibility makes power curves an
important piece of the strategic con-
text. Senior executives must understand
them and respect their implications.
Michele Zanini is an associate principal in
McKinseys Boston offce.
1
See Lowell L. Bryan and Michele Zanini, Strategy
in an era of global giants, mckinseyquarterly.com,
November 2005.
2
The power laws phenomenon has been explored in
the recent books The Black Swan: The Impact
of the Highly Improbable (Nassim Nicholas Taleb,
Random House, 2007) and The Long Tail: Why
the Future of Business is Selling Less of More (Chris
Anderson, Hyperion, 2006).
i
z
is rle iooirion o vaiiance exlaineu Ly a iegiession.
Souice: Pensions & Invesrmenrs: NcKinsey analysis
450
500
400
350
300
250
200
150
100
50
0
5 10 15 20 25 30 0
Rank by 401(k) assets under management
US 401(k) assets under management by top 30 companies, 2006, $ billion
r
2
= 0.98
measure/subtitle
r x n i v i 1 (
A steep slope
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Strategic decision making in uncertain times

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