ENVIRONMENTAL UNCERTAINTY

Literature Review and Strategic Classification

Managerial Decision-Making
Bounded rationality
Information required vs. information available
Cost of obtaining missing information
Temporal window for making the decision
Limitations of human cognition
Environmental uncertainty
Dimensions of the environment
Vectors and rates of change
Definition
An inability to assign probabilities as to the likelihood of
future events (Duncan, 1972; Pennings & Tripathi, 1978;
Pfeffer & Salancik, 1978)
A lack of information about cause-effect relationships
(Duncan, 1972; Lorsch & Lawrence, 1965)
An inability to predict accurately what the outcomes of a
decision might be (Downey, Hellriegel, & Slocum Jr, 1975;
Hickson, Hinings, Lee, Schneck, & Pennings, 1971;
Schmidt & Cumming, 1976)

(Milliken, 1987)
Financial Times 45 Citation Examination
Management Field
Sample Population
141 journal articles
Divided into three timeframes
1966 1980 (early development)
1981 1995 (refinement of measures)
1996 present (construct frozen)
Article count by fields of management
General = 69
Strategy = 47
Operations = 14
Information = 7
Entrepreneurship = 4

Two Types
Objective (OEU)
Economic in origin (Simon, 1957)
Supply uncertainty
Demand uncertainty
Cost uncertainty
Perceptual (PEU)
Market, scientific, and plant sectors of the environment along with
certainty of information, rate of change of the environment, and
time range of task as the vectors impacting bounded rationality
(Lorsch and Lawrence, 1965)


Construct Research
Construct Research
PEU OEU Test
Tosi, Aldag, and Storey (1973) investigated Lorsch and
Lawrences perceived measures and scales, and checked
their results against objective measures of the
environment.
They found little correlation between perceived and
objective data
The debate continued for seven years

PEU-OEU Resolution
Bourgeois (1985) recognized that each type of measure
had a place in management studies.
Objective measures of environmental uncertainty were well suited
for the initial stage of strategic planning that is domain identification
and selection.
Perceptual measures of environmental uncertainty were a better
indicator when studying managerial decision making involved with
domain navigation as the firm attempted to fit the environment.

PEU-OEU Measures and Scales Integration

Miller and Friesen (1982) recognized three dimensions
Environmental dynamism
Environmental heterogeneity
Environmental hostility

Dess and Beard (1984) recognized three dimensions
Dynamism
Munificence
Complexity

Miller & Friesen (1982)
Miller & Friesen (1982)
Miller & Friesen (1982)
OEU Measures and Scales
Keats and Hitt (1988) refined the Dess and Beard
measures with regression equations:
Growth and volatility in industry sales
Growth and volatility in industry operating income
Three-part calculation of industry concentration
Grossacks (1965) dynamic measure
Four-firm concentration ratio
HerfindahlHirschman Index (Hirschman, 1964)
EU Research
Environmental
Uncertainty
Objective Perceived
Economy
Industry sales
Industry growth
Concentration
Costs of inputs
Technology (R&D cost
& patents)
Capital markets
Economy
Customers
Competitors
Suppliers
Technology (pace)
Capital markets
Regulators
Unions
Range of
unpredictability
Dynamism
Municence
Complexity
Strategic Classification
Following Bourgeois (1985), use OEU as means of
identifying and selection strategic domains.
Porters Five Forces
Threat of
New
Entrants
Customer
Power
Supplier
Power
Threat of
Substitutes
Threat of
Competitive
Rivalry
Porters Five Forces as OEU
Bargaining power of suppliers
Impact of inputs on cost or differentiation
Importance of volume to the supplier
Differentiation of inputs
Competition between producers
Size and concentration of suppliers relative to industry
Switching costs
Asymmetry of suppliers information
Suppliers ability to forward integrate

Bargaining power of suppliers
Impact of inputs on cost or differentiation
Calculate the suppliers contribution to margin, take the natural logarithm of
that figure and regress over at least five years against an index such as
the S&P 500. The antilog of the regression coefficient will represent
munificence (growth) while the antilog of the standard error indicates the
dynamism (volatility).
Y
i
^
= b
0
+ b
1
X
i
+
i
e
b
1
= munificence measure
e

= dynamism measure
where Y = ln(supplier's contribution to margin)
and X = index/year measure
Bargaining power of suppliers
Importance of volume to the supplier

Determined using the measures of supplier industry concentration: Grossacks
(1965) dynamic measure of industry concentration, the four-firm concentration
ratio, and the HerfindahlHirschman Index (Hirschman, 1964).

Grossack is a regression of current-year market shares of all firms in a given industry
upon their shares 5 years ago. The reciprocal of the regression coefficient indicates
the decrease or increase of monopoly power in the industry and is used as one
measure of complexity.

HerfindahlHirschman measures the smallness among the number of firm and the
variation among the sizes of firms

Bargaining power of suppliers
Supplier industry concentration
Grossacks Measure
Herfindahl-Hirschman Index
b =1+ w
i
i

y
i
x
i
x
i

w
i
=
x
i
2
x
i
2
i

b = r

x
=
y
i
2

x
i
2

C(HI ) =
HI
y
HI
x
=
y
i
2
+
1
n
y
x
i
2
+
1
n
x
HI
x
= X
i
2
i
+
1
n
where X is the market share of the i
ith
firm expressed
as a ratio and n is the number of firms in the industry
Bargaining power of suppliers
Differentiation of inputs
Differentiation is linked to above-average profits
Regress the natural log of the operating profit margin for the supplier
industry against an index variable of years
Antilog of the regression coefficient represents supplier OPM growth
Antilog of the standard error represents supplier OPM volatility
Y
i
= b
0
+ b
1
X
i
+
i
where Y = ln(supplier OPM)
and X = index/years
e
b
1
= supplier OPM munificence
e

= supplier OPM dynamism

Bargaining power of suppliers
Competition between producers
Determined by regressing unit prices against an index variable of
years.
Regression coefficient represents price growth (complexity)
Standard error represents price volatility
Y
i
= b
0
+ b
1
X
i
+
i
where Y = unit prices
and X = index/years
b
1
= unit price complexity
= unit price dynamism
Bargaining power of suppliers
Size and concentration of suppliers relative to industry
Calculate Grossacks concentration index for producer and supplier
industries and regress this ratio against an index variable of years.
Regression coefficient represents producer/supplier complexity
Standard error of regression indicates producer/supplier volatility
b =1+ w
i
i

y
i
x
i
x
i

w
i
=
x
i
2
x
i
2
i

Y = b
0
+ b
1
X
i
+
i
b
p
b
s
= Y = producer/supplier concentration ratio
X = index variable of years
Bargaining power of suppliers
Switching costs
Static measure using ranked scale
1 = low impact
2 = moderate impact
3 = high impact
Determined using NPV of switching costs
Measure of complexity
Bargaining power of suppliers
Asymmetry of suppliers information
Static measure using ranked scale
1 = Supplier provides financial data, producer does not
2 = Both producer and supplier share financial data
3 = Neither producer nor supplier share financial data
4 = Producer provides financial data, supplier does not

Bargaining power of suppliers
Suppliers ability to forward integrate
Determined by computing the number and strength of related
acquisitions by suppliers and regressed over an index variable of
years.
Using logistic regression over an index variable of years, determine the
probability of supplier-sourced related acquisition
Multiply this number by the natural log of the value of the acquisitions

ln
p
1 p

= b
0
+ b
1
X
i
e
ln
p
1 p

= odds ratio
Probability =
OR
1+OR
Bargaining power of suppliers
Suppliers ability to forward integrate
Determined by multiplying the number and value of related
acquisitions by suppliers in each year of the period; take the natural
log of these figures and regress over an index variable of years.
Antilog of regression coefficient represents complexity
Antilog of standard error indicates volatility


Y = b
0
+b
1
X
i
+
i
where Y = ln(number i value of acquisitions)
X = index variable of years
Bargaining power of suppliers
OEU Summary
Bargaining power of customers
Cost of product relative to total customer purchases
Differentiation of outputs (product differentiation)
Importance of volume to customers
Competition between customers
Customer profitability
Size and concentration of customers relative to industry
Customers switching costs
Asymmetry of customers information
Customers ability to backward integrate

Threat of New Entrants
Economies of scale
Absolute cost advantages
Capital requirements
Product differentiation
Access to distribution channels
Government and legal barriers
Retaliation by established producers
Market share shifts
Threat of New Entrants
Economies of scale
Perform industry concentration computation for producer industry:
Grossacks measure
Four-firm concentration ratio
Herfindahl-Hirschman index
Higher concentration indices represent greater economies of scale
as a complexity measure
Threat of New Entrants
Absolute cost advantages
Dependent upon unique contingencies
However, proxy measure could be implemented as:
Tobins q
Measure of value of technological assets; brand equity; intangible value
Number of patents awarded to the industry and regressed over an index
variable of years
f
2
R
q
i
r
m
i
Y
qK +
M
p

qK +
M
p
( )
=
M
p
Threat of New Entrants
Capital requirements
Specific capital requirements are contingent by entrant.
Better understanding may come from access to and cost of capital
Take the natural logarithm of the total liquidity of the credit market and
regressing against an index variable of years provides the foundation
from which the antilog of the regression coefficient is used as a
measure for capital market growth. Further, the antilog of the standard
error of the regression coefficient represents the measure of credit
market volatility.
Additional measure could be added in the form of a regression equation
computing the coefficient and standard error of capital rates over an
index variable of years.

Threat of New Entrants
Product differentiation
Take the natural logarithm of the total operating profit margin of the
producer industry cataloged by four-digit NAICS code and regress
against an index variable of years; the antilog of the regression
coefficient is used as a measure for operating profit margin growth.
Further, the antilog of the standard error of the regression coefficient
represents the measure of operating profit margin volatility.
Threat of New Entrants
Access to distribution channels
A suitable proxy is the four or eight-firm concentration ratio; higher
levels of industry concentration will inhibit access to distribution.
Capturing several years of data could then be regressed and
examined as complexity and dynamism measures.
Threat of New Entrants
Government and legal barriers
The uncertainty of government and legal barriers might be captured
as the number of regulatory actions taken at the national, provincial,
and local levels against the industry and ranked by severity:
3 = strategic impact
2 = operational impact
1 = paperwork impact
Means could be calculated by year for an index variable of years.
The Friedman Two-Way ANOVA by Ranks could be applied to
ensure a significant differentiation between ranked categories.
Capturing this data by year would allow a regression equation
where the regression coefficient is a measure of complexity while
the standard error is volatility.
Threat of New Entrants
Retaliation by established producers
Dependent upon the market entry strategy employed by new
entrants (Kotler and Keller, 2009):
Frontal attack
Flanking attack
Encirclement
Guerilla warfare
Threat of New Entrants
Market share shifts
Use Grossacks expanded measure of the producer industry to
discover if new entrants are affecting industry concentration.
b = r

x
=
y
i
2

x
i
2

C(HI ) =
HI
y
HI
x
=
y
i
2
+
1
n
y
x
i
2
+
1
n
x
Threat of New Entrants
OEU Summary
Threat of Competitive Rivalry
Cost conditions (fixed and storage)
Unique to producers dependent on their strategy
Cost-based
Differentiation
Niche
Contingencies include
Organizational structure
Supply chain
Intellectual and human capital

Threat of Competitive Rivalry
Concentration of producers
Grossacks dynamic measure of industry concentration, the four-firm
concentration ratio, and the HerfindahlHirschman Index.
However, we caution researchers about the use of producer
concentration as the sole measure of complexity because of the
competitive stratification generated as a result of niche strategies.
Threat of Competitive Rivalry
Diversity of competitors
Regress the number of producers against the number of strategic
business units over an index variable of years.
Regression coefficient represents producer diversity complexity
Standard error indicates diversity volatility
Y
i
= b
0
+b
1
X
i
+
where Y = number of producers
X
i
= number of SBUs
Threat of Competitive Rivalry
Product differentiation
Take the natural logarithm of the total operating profit margin of the
producer industry cataloged by four-digit NAICS code and regress
against an index variable of years
The antilog of the regression coefficient is used as a measure for
operating profit margin growth.
The antilog of the standard error of the regression coefficient
represents the measure of operating profit margin volatility.
Threat of Competitive Rivalry
Excess capacity
Regress the natural logarithm of the industry capital investment
against the natural logarithm of the industry sales to uncover
capacity breakpoints and estimate excess capacity.
Threat of Competitive Rivalry
Exit barriers
Detect growth in the number of producers as determined by the
measures for industry concentration ratio and map against
moderate to high sales growth; this indicates lower exit barriers
because a market exists to dispose of structural elements.
Detect a decline or stasis in the number of producers as determined
by the measures for industry concentration ratio and map against
slow sales; lack of growth indicates higher exit barriers because a
market does not exist to dispose of structural elements.
These measures represent complexity components
Threat of Competitive Rivalry
OEU Summary
Threat of Substitutes
Switching costs
Buyer inclination to substitute
Price-performance trade-off of substitutes
The Dess and Beard OEU Classification Framework
The Porter
Four Forces
as OEU
Dynami sm Muni f i cence Compl exi t y
Suppl i er Mar gi n
Cont r i but i on,
Suppl i er
Concent r at i on,
Oper at i ng Mar gi n,
Uni t Pr i ce,
Pr oducer Revenue/
Cust omer Cost Rat i o,
Cust omer
Concent r at i on,
Cust omer OPM,
Capi t al Li qui di t y Si ze,
Capi t al Rat es,
Di st r i but i on
Channel s,
# of Pr oducer s,
Suppl i er Mar gi n
Cont r i but i on,
Oper at i ng Mar gi n,
Uni t Pr i ce,
Cust omer OPM,
Capi t al Li qui di t y
Si ze,
Capi t al Rat es,
Di st r i but i on
Channel s,
# of Pr oducer s,
Excess Capaci t y
Cal cul at i on,
Obj ect i ve Envi r onment al Uncer t ai nt y
Pr oducer /Suppl i er
Revenue Rat i o,
Suppl i er
Concent r at i on,
Pr oducer Swi t chi ng
Cost s (r anked),
Inf or mat i on Asymmet r y
(P/S r anked),
Suppl i er Rel at ed
Acqui si t i on Pr obabi l i t y
& Power ,
Pr oducer Revenue/
Cust omer Cost Rat i o,
Cust omer Pur chase/
Pr oducer Revenue
Rat i o,
Cust omer
Concent r at i on,
Cust omer Swi t chi ng
Cost s (r anked),
Inf or mat i on Asymmet r y
(P/C r anked),
Cust omer Rel at ed
Acqui si t i on Pr obabi l i t y
& Power ,
Four -f i r m
Concent r at i on Rat i o,
Pr oducer Tobi n's q
Gover nment Act i ons
(r anked),
Pr oducer
Concent r at i on,
Pr oducer Rel at ed
Acqui si t i ons,
Exi t Bar r i er
Cal cul at i on
Limitations
Access to financial and regulatory information
Public vs. Private
U.S. vs. ROW
Lack of empirical evidence as of yet
Future Research
Instrument development process
(Chen and Paulraj, 2004)