The exploration versus exploitation question is an age-old one for businesses . However, in today's business environment, this question has acquired a very intense hue. Indian companies have to take strategic decisions in an extremely complex environment characterised by the emergence of new consumers, employees, technologies, competition and policies. This question has very different implications for a large incumbent compared to a new challenger. In fact, a study of the change in market positions of companies reveals leadership is more fickle today than ever before (see Continuously Shifting Market Position). Therefore, striking the right balance between exploration and exploitation has material implications on the very existence of a company.
There are additional layers of complexity for a large incumbent with a relatively successful business model. There is an intense lure of improving existing business which can create substantial value in the immediate term. New bets, however, require the leadership to make difficult strategic choices in an already dynamic environment and typically these bets yield late results. Resources are limited, hence allocating them between existing versus new opportunities is a challenge.
BCG [The Boston Consulting Group] Strategy Institute has identified five traps that companies can fall into, as they fine-tune their exploration versus exploitation approach. These traps, and tools to navigate them, are:
BACKYARD EXPLORATION VERSUS COMBING THE OCEAN:
The first step toward solving the exploitation versus exploration conundrum is to be clear about where to look. Backyard exploration focuses exclusively on existing opportunities. US auto majors in the 1980s and 1990s were busy sweating existing automobile platforms whereas Toyota launched Prius - now the world's top-selling hybrid electric vehicle. The tendency to focus all resources on existing opportunities is symptomatic of this trap. To steer clear, companies need to create a culture of curiosity. Employees need to be encouraged to explore new vistas in the existing business (depth) as well as explore the adjacent spaces (breadth) - a T-shaped exploration. Companies need to collaborate with partners for continuous innovation. This allows them to continuously scan new ideas with a measured up-front commitment of organisational resources.Combing the ocean attempts too many experiments superficially. During the mid-1990s in the US and Europe, 'do-a-bit-of-everything' conglomerates suffered a conglomerate discount and underwent deconstruction. Typically, companies stuck in this trap show extreme conglomeration tendencies - nothing is out of scope, synergistic logic across opportunities is weak and incremental return on innovation is not well articulated. To avoid this trap, companies need a clear vision linked to their unique sources of advantage. For example, Google redefined its vision from 'creating the best search engine' to 'knowing everything'. Companies need a disciplined portfolio management approach to classify existing and new opportunities into scale-up, manage-for-cash, turnaround and exit categories. Three portfolio lenses need to be deployed - strategic attractiveness, economic attractiveness and parenting attractiveness. A scientific corporate venturing process is a must to generate tangible value from ideas.
TRAPPED IN THE PAST VERSUS PERPETUAL SEARCH:
It is critical to calibrate the right balance for allocating resources between explore and exploit opportunities. Trapped in the past is regressing to seemingly tried-and-tested ideas that worked in an old context, in the face of new uncertainty.
Perpetual search is excessive focus on exploring new ideas with low emphasis on commercialisation. Xerox's PARC lab created some pioneering intellectual property. Microsoft and Apple created billions of dollars of value by commercialising the same ideas whereas Xerox merely created demo-versions. Companies fall in this trap when they link incentives to merely the intellectual exercise. Commercialisation needs to be rewarded and not mere ideation. In a dynamic environment, agile commercialisation approaches are best suited where a 'minimum viable product' is defined in quick iterative cycles and exposed to market within weeks.
MISJUDGED HARSHNESS VERSUS UNDERLEVERAGED RESOURCES:
The question of resource allocation is moot without an understanding of available resources and future requirements. Misjudged harshness is underestimating resources required to be resilient in a harsh environment. PanAm was a pioneering airline in terms of its operating model and was very profitable. It used jet planes across 86 continents and operated a heterogeneous fleet with decentralised infrastructure. During the oil crisis of 1970s, the hidden costs of their model namely, heavy overheads and operating costs, were exposed. Their resources drained faster than they could restructure, eventually resulting in bankruptcy. To navigate this trap, companies need to stress test their business model through scenarios analysis. A scenario is a version of the future that is uncertain but has high potential impact. Existing and new opportunities need to be stress tested under different scenarios to identify resource gaps and interventions required to build resilience.
Underleveraged resources is missing out on opportunities by under-leveraging available resources. Apple had cash reserves of $147 billion in 2013. However, it ranked 46th on R&D spend. Today Apple does not seem to have game-changing projects in the pipeline like Google X. There are two approaches to navigate this trap. One is a company-in-company model where a ring-fenced child company is created with the mandate to build completely breakthrough and at times attacker businesses. The other is an organisational solution where distinct run-the-business and change-the-business teams are created. Change-the-business teams are mandated to launch powerful interventions to transform the existing businesses and build new ones.
DROP IN THE OCEAN VERSUS RISKING THE SHIP:
It is critical to ensure that resources deployed against each opportunity are commensurate with investment needs. Drop in the ocean is underestimating long term resource requirements to fully capture an opportunity. When DHL entered the US freight market in 2003, it took on large incumbents UPS and FedEx. To beat them, DHL needed to invest heavily to build scale. While DHL's investment at $10 billion was sizeable in absolute terms, it was inadequate resulting in its eventual exit from the business in 2008.Companies caught in this trap display a gap between ambition and commitment. This gap is attributable to intellectual indiscipline in the form of poorly written business cases which miss the big picture and make an opportunity appear achievable with unrealistically low investments. To avoid this trap, ideas need to be assessed for scalability and business cases need to reflect the resources required. Equally important is overcoming the mindset challenge where management develops cold feet just before major investment milestones. It helps to sustain the teams that take the opportunity from design to steady state. Early engagement of people ensures emotional connect with the idea and helps the idea survive.
Risking the ship is staying the course when an opportunity ceases to be attractive. To get back in the game, Windows and BlackBerry singularly placed their bets on replicating iOS and Android's ecosystem. However, their combined market share just managed to reach five per cent. Companies caught in this trap display a 'silver bullet' mindset where one big bet is expected to restore competitive advantage. Instead companies need to develop five 'adaptive advantage', which comprises five capabilities, i.e., signal - sense and amplify the right signals; experimentation - economically conduct many experiments; organisation - structurally expose organisational entities and market reality; system - source ideas from the ecosystem; and eco-social - align opportunities with social and ecological context.
FIXED ITINERARY VERSUS FORGETFUL WANDERER:
If exploration rates exceed or lag the rate of change in the environment, companies can either miss opportunities or burn resources on fads. Fixed itinerary is a static approach towards resource allocation. Kodak's digital camera debacle is well known. However, in 1957 itself, a Kodak engineer had built the first digital camera prototype. Yet, even in the 1990s when cell phones with built-in digital cameras started hurting Kodak, it did not allocate resources adequately to ensure survival.
Forgetful wanderer is falling for the latest trend while ignoring past lessons. During the dotcom bubble, investors destroyed $5 trillion of value by following a fad. Companies that avoid this trap maintain a repository of past exploration attempts. Inputs from this repository are fed into future explorations to inform resource allocation decisions.
(Ashish Iyer is Senior Partner and Director and Global Leader for Strategy Practice, BCG; Yashraj Erande is Partner, Director and Strategy Head India, BCG)