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.