Estimating probabilities is key to strategy

Leaders must be good at taking bets against the future. They must be able to choose a course of action that is most likely to advance their organization in an uncertain world. Competent leaders make the right bets most of the time; bad leaders don’t.

However, many of the leaders I help are overwhelmed by the strategic choices facing their non-profit organization or social enterprise. 

They have realized that they have limited resources such as time, attention, money and people. They recognize that they cannot pursue all opportunities. Neither can they protect against all threats and risks, with equal enthusiasm, despite wanting to do so. They have learned that the future is uncertain and unpredictable. They have begun to accept their limitations as leaders.

Most of the time I feel the same.

Agony of choice in an uncertain future 

An agony of choice arises the moment we try to focus our thoughts and actions. This may happen when we seek to apply the Pareto 80/20 Principle or the Pumpkin Plan. It may emerge when wondering where to invest our marketing efforts, or which necessary endings or strategic shifts to make. It will happen whenever we need to speculate on how the future will turn out and choose a course of action.

When interrogating their options, leaders use their intuition and available facts to run an equation that may look something like this:

(Outcome Value x Probability) / (Cost + Time + Disruption) = Opportunity Attractiveness

If the value of the outcome multiplied by the probability of it occurring is greater than all the costs involved in working towards it (including the opportunity cost), then it becomes an attractive consideration. However, if this is not the case, then the opportunity should most probably be discarded. 

It is a calculated gamble to estimate probabilities and make decisions. But it is one that we are making all the time for our organizations, and in our lives. Estimating the probability that a certain set of actions will yield a desired outcome is something that leaders must do each day. It is integral to running a successful organization.

Leaders can mitigate the agony of choice by doing their homework. This may involve gathering data, reviewing research and speaking to advisors. The amount of homework will depend on the choice we need to make. But at some stage, this homework will start to produce diminishing returns and leaders must be careful not to be stuck in “analysis paralysis”. Leaders must then make their choices and roll the dice.

Since the future is unknown to us, and not as stable as it used to be, these choices carry an inherent risk. We can wait for the future to reveal itself, but then it may be too late. The opportunity may vanish or the risk may undermine our organizations.

Unfortunately, donors and investors tend to be risk averse when compared to social entrepreneurs. They struggle to grasp the complexity of the problems we deal with in the social sector. Neither are the solutions to these problems straightforward. Solving them requires a willingness to embrace uncertainty and risk. We need to rely on our intuition and adapt our approach as we go along. The best solution can rarely be forecast in a way that satisfies investors and donors. 

Examples of estimating probabilities

Here are three examples from my past week where I’ve been involved in estimating probabilities and “predicting” the future:

The first example concerns my wife’s job search:

My wife was recently retrenched when the social enterprise she worked for underwent a financial restructure. Now she is busy hunting for a new job that fits her values and will further her career in operational systems. 

She has chosen to spend 90% of her time for the next six weeks studying to become a Certified Associate in Project Management (CAPM) with the Project Management Institute (PMI). The remaining 10% of her time involves looking at job adverts. She is aware that a job search involves much more than looking at adverts. But she estimates that her time spent on this qualification is more likely to contribute to the job she wants than any alternative option. Then in six weeks, she will invest 100% of her time hunting for suitable work using the full range of job search techniques. 

She is making her bet with open eyes, and is well aware of the risks.

This next example concerns a community development strategy we’re designing for a mining trust:

There is so much poverty within the Trust’s beneficiary communities. It also has limited money and time before the mine closes to make a difference. If it tries to fix everything, then it will most likely achieve nothing of lasting value. It must choose where to intervene.

Research shows that the broad increase of household income across a community contributes to the reduction of poverty. We also know that entrepreneurship and job income contributes to household income. Thus, we can assume that helping people to start and grow their businesses, and acquire skills and find decent work, is more likely to contribute to the reduction of poverty than the next best option.

We are proposing that the Trust focus 90% of its resources in this area. It is a calculated bet that we are proposing – one that is informed by rigorous research and reasoning, and an assessment of other strategic factors.

This next example concerns a research consultancy that I work closely with. 

This research company provides services to universities, non-profit organizations, government and corporates. Over the past decade, each of these markets has become more competitive. Specialist organizations have positioned themselves in each.

The company has realized that it cannot be successful in all markets. It has too few resources to do this. It must make some difficult choices.

The company has decided to focus its marketing efforts on universities and non-profit organizations. Investing its efforts on these customers is more likely to attract the type of work it wants to do. It resonates with these customers, and they appreciate scientific research. They speak the same language. They also have a shared concern for the social problems facing South Africans.

This choice of focus is not without consequences. The company must increasingly let go of opportunities to do government and corporate research.

The opportunity costs

We must consider “opportunity costs” and “next best alternatives” when we bet against the future.

For example, we recently helped a non-profit organization to decide on the programmes that would have the most social impact. To assist us with this task, we conducted two thought experiments.

The first was what would happen if we gave this money away to beneficiaries in the form of a basic income grant? Either a single lump sum or monthly payment over a period. The second was what would be the most straightforward programme that could run with the same funding? Our planned intervention had to produce much more impact than these two alternatives for it to be worth implementing. 

Probability of risks or threats

Leaders must also be able to estimate the probability that a risk or threat will occur. They can then take appropriate action to mitigate these risks in advance.

Estimating risk requires that leaders to be in a state of strategic clarity. Some risks may be very unlikely to happen, but very catastrophic if they do. Consider “Asteroid 2019 OK” which barely missed earth. It would have caused an explosion 35 times that of the nuclear bomb that detonated at Hiroshima if it had hit us.

Turning to some less apocalyptic common examples. Imagine if the CEO/founder of a social enterprise had a heart attack. What would be the impact on this organization? Or what would happen if your largest donor pulled out of South Africa, or if your top employee resigned. I have worked with organizations that have experienced these exact challenges.

Leaders must be able to assess the probability that a risk will occur and the potential severity of it. This will enable them to make decisions and allocate resources. But, they will still need to gamble. Organizations lack the resources to mitigate every risk that appears on the horizon.

Inherent biases in estimating probabilities

Human beings are excellent at estimating probabilities as this is an evolutionary trait. But we are also subject to a long list of cognitive biases which undermine our ability to think clearly. 

Let me name some I’ve recently experienced. We tend to underestimate the probability that a threat will occur. We tend to overestimate our ability relative to others. We are all guilty of the “planning fallacy” – our tendency to underestimate the resources we need for a strategy or project. I see the consequences of this in all my work. This is why it’s so important for a leader to become aware of the biases in their mental hardware, as they must compensate accordingly. 

Conclusion

Leaders are bound to make bets that fail. They must make rapid and uninformed decisions. This is life. It is unfair and short-sighted to think a leader is incompetent because a bet has backfired. However, if a leader makes bets that consistently backfire, then it would be fair to question their competence.

There is more danger in a leader not acting, than taking action in the face of an unknown future. I’ve seen more organizations flounder or fail because of inaction than because of poor action.

As a general strategic principle, it’s always better to focus one’s resources. I understand the desire for leaders to attempt to reduce risk through a diversified approach. But in our competitive marketplace, we need extreme focus to stand out, achieve the impact we desire, and advance our organizations.

Thanks to Andy Simpson (Imani Development) and Philip Anastasiadis for their insightful contributions to this article.

In pursuit of strategic clarity

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