Hidden costs

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En provenance du cours de Copenhagen Business School

Strategy Formulation

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Copenhagen Business School

Strategy Formulation

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Cours 2 sur 4 dans Specialization Strategic Management and Innovation

The purpose of this course is to present, analyze and discuss the different facets of business strategy formulation. Emphasizing that strategy can be seen as a unified theme that provides coherence and direction to the actions and decisions of a firm, we will cover a variety of business strategy topics concerned with firm positioning in the context of different markets, industries and locations. At the end of the course, you will be able to: - Identify why a strong strategy is essential for the future business success - Formulate a business strategy that suits the needs and visions of your organization - Explain why managers too often formulate sub-optimal strategies - Extrapolate measures to optimize current business strategies Workload: 2-4 hours per week.

À partir de la leçon

Strategic decision making

In this module, we will investigate the processes of strategic decision making and explore how this matters for firm performance. We will discuss topics such as ‘bounded rationality’, management politics, and hidden costs.

Strategy as forecasting5:03

Hidden costs3:39

Rencontrer les enseignants

Marcus Møller Larsen
Assistant Professor, Strategic Management and Globalization
Department of Strategic Management and Globalization

In the following, we'll explore a key question, namely,

what happens when decision makers are not able to foresee and

anticipate the cost of their newly formulated strategies?

As we've already talked about, an effective strategy is

one where the future value of the strategy outweighs the future costs.

If the opposite is true, if the future cost outweighs the future value,

then we can rather comfortably conclude that the strategy is a bad one.

However though, this exercise may not be as straightforward and easy as it sounds.

In particular, if you consider that managers and

decision makers in firms suffer from bounded rationality, and specifically,

an inability to process a large amount of information over short periods of time.

We may quickly end up in situations where decision makers either over-emphasize

the benefits of a given strategy and then consequently down-prioritize the cost,

or perhaps completely forget about the cost sides in general.

A good example here is Lego.

Lego concluded that there were huge benefits of outsourcing their production,

but at the same time they may have underemphasized

the cost of making this transition.

In this respect, we can talk about something which we call hidden cost.

Specifically, if we acknowledge that firms often find

that unanticipated costs erupt and challenge the very strategic intent of

the rationale of the decision that they have formulated, they are ending up in

situations where these costs have been ignored, or overlooked, and

therefore are hidden, by the decision maker in the decision making process.

You can therefore talk about certain costs, these hidden costs,

that's the X and the unaccounted for, which is why the materialized

exposed as the discrepancy between the expected and the realized costs.

Why do we see that some decision makers are less able to account for

the full costs of their strategies?

As already hinted at, we need to remember that decision makers are humans

like you and me, and that humans aren't able to process

all relevant information at all times before making their decisions.

Especially when facing large and complex problems where decision makers need to

process large amount of information to make a somewhat informed and

rational decision, they are larger risk of making mistakes.

Again, like you and me.

This is of course completely understandable.

However though, what can firms do about this?

Well, one thing is to simply acknowledge that it is impossible to account for

all factors that my influence a strategic decision.

As to say, that's life.

Mistakes happen.

You could plan for some deviations when making your strategies.

Another option, however, is to systematize ways of exploiting the knowledge and

the information that is required to make a more informed and more rational decision.

For example, one could think about hiring industry experts

whenever they wanted to make a new strategy.

Under all circumstances, we need to understand that humans make mistakes,

even when it comes to making important strategic decisions.

And that while such mistakes may seem painful at the time it

hits the organization, it can also provide a golden opportunity for

gaining new knowledge that may inform strategic formulation in the future.

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