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Managing pharma's uncertainty

Futures we can’t predict need a strategy we can’t plan
Managing pharma's uncertainty

All business is risky but the life sciences sector is especially so. The huge investments needed, combined with the uncertainties of advanced science, mean that our business is all about understanding and managing risk. Historically, strategic planning in life sciences has been about estimating risks and placing bets accordingly; the best estimators won a blockbuster. But what about when, as now, a period of intense turbulence makes some risks, especially long term and strategic risks, impossible to estimate? This question is at the leading edge of economic research and the answers it is throwing up have big implications for how we might approach strategy.

Knights and Black Swans
Our story starts with one of the most influential economists of the 20th Century, a Chicago professor called Frank Knight. His most famous book, Risk, Uncertainty and Profit, was built on the seminal idea that not all risk is the same. He introduced the idea that some risks were measurable while others were intrinsically immeasurable. The latter category has become known as 'Knightian Uncertainty'. So for example there is a measurable risk that our new product may not get the phase III results we need and we can assign a probabilistic estimate to that risk. By contrast, the probability that a newly discovered piece of fundamental science may lead to a commercially viable market in twenty years time is impossible to calculate and is therefore a Knightian Uncertainty. 

From their origins in economics and finance, Knight's ideas have spread into many different fields. Naseem Nicolas Taleb's 2007 book The Black Swan, which built on Knight's ideas, was a global best-seller and is said to have influenced many politicians and other scientists. The basic premise of this uncertainty line of thinking is that one can't plan for uncertainty the same way that one can plan for measurable risks. In the latter situation, we can use traditional approaches, labelled causal reasoning by academics, which rely on our understanding of cause and effect. But when thinking about outlying, low-probability high impact events this approach becomes useless. A better approach is to build a strategy that is robust, in anticipation of negative shocks, and flexible, to exploit positive surprises. This way of thinking is conceptually attractive when the environment is unstable and hard to predict. But how might it be applied in the life sciences sector? 

Entrepreneurial Ideas 
To apply the Knightian Uncertainty to the life sciences market, begin with when it is relevant and when it is not. When the future is predictable – for example in existing markets with existing technology - we can stick with traditional approaches based on ideas of cause and effect. Even if there is a risk that our market assumptions may be incorrect, we can still estimate that risk and find ways to mitigate or offset it. When we are dealing with big, complex issues with lots of variables – the future of the Chinese market perhaps or the convergence of pharma and information technology – we need to think in Knightian terms.

As for who we can learn from, don't expect to pick up an industry best practice case study on managing uncertainty, the ideas are too new for that. Instead, our research is finding fragments of emerging practice in many leading companies but no one seems to have put it all together into a 'Knightian Uncertainty management process' yet. And, as often happens when new thinking emerges, what we observe is the importation of ideas from another field altogether. 

So where should we look for exemplars of how to manage uncertainty that are robust in the face of negative shocks and flexibly opportunistic when opportunities arise? We shouldn't look to our own industry, which has been relatively stable for decades. Instead, we should look at the people whose lives are dominated by uncertainty and immeasurable risk: entrepreneurs and innovators. This is exactly what Saras Sarasvathy did, when she looked at the behaviour and practice of serial entrepreneurs and innovative companies. She found exactly what Knight and Taleb's work suggested: practices that built up robustness in the face of bad events (anti-fragility as Taleb later called it) and flexibility in the face of unexpected opportunities. In her work, Sarasvathy observed practice under conditions of Knightian uncertainty that is quite different from causal reasoning, a pattern of behaviour she call effectuation. 

At the heart of effectuation behaviour lie five characteristic behaviours or principles:

  • The Bird in the Hand Principle. This means imagining possibilities that originate with firms' assets, resources and capabilities, rather than looking at the market as it is currently defined. For example, a pharma company with exceptional understanding of and connections in the diabetes market might prepare itself to be a diabetes management company, rather than a maker of diabetes drugs 
  • The Focus on the Downside Principle: This means understanding what can be lost instead of simply what can be won. This helps to mitigate the threat from substitute technologies. For example, a company with existing interests in mental health drugs might choose to prepare for non-pharmaceutical therapies, knowing that it is better to win in the growing new market than in the shrinking old market 
  • The Crazy Quilt Principle: This means building a network of partnerships, early in any venture, by obtaining pre-commitments from key partners. This both reduces uncertainty and helps create new markets. A company co-operating with patient advocacy groups, IT companies and governments to develop the telemedicine market might be an example of this 
  • The Lemonade Principle: This means interpreting surprises as signals and clues to the market, rather than creating scenarios. This enables the flexibility to react to change. For example, a firm might see the rejection of market access as an opportunity to develop a 'beyond the pill' extended value proposition
  • Pilot in the Plane: This means focusing on factors that are within the firm's own sphere of control rather than external and uncontrollable factors. This allows whatever market factors emerge to be influenced to be shaped in the firm's favour. For example, a company might engage with leading edge health-economics research or technological development in order to set industry standards. 

Not business as usual
These five principles of effectuation are intended to make a business much more robust to the downsides of uncertainty and more adaptable to its upsides. As the small examples above suggest, we see fragments of effectuation practice in many companies but the full-blown use of the concept in none as yet. Why is this? Well, one explanation is that the largest proportion of strategy work is done under conditions of probabilistic risk and so doesn't need an effectual approach. And it is in the nature of human beings that if most of their time is spent in 'causal thinking' mode then they will find it difficult to switch to effectual mode in the minority of situations in which they face a high degree of Knightian Uncertainty. But we still need an explanation for why very bright executives who can see that traditional approaches don't work still usually default to that ineffective methodology. 

Traditional practiceEffectual practice
Identification, definition, characterisation, quantification and prioritisation of market opportunities based on industry-standard quantitative data Extensive and rigorous assessment of the firm's distinctive assets, resources and capabilities (both tangible and intangible) followed by wide-ranging exploration of how any advantages may create market opportunities
Resource allocation choices evaluated in terms of discrete opportunity size, with emphasis on growth opportunities and de-emphasis on the costs of inactionResource allocation choices evaluated in terms of overall results of total activity, with emphasis on potential downsides of inaction 
Integrated structure with outsourcing of non-core activities on a contractual basis and partnering to acquire specific IPR or capabilitiesDis-integrated structure within a network of inter-firm relationships designed with equal attention towards capabilities, risk management and market creation
Reaction to unplanned and unexpected events by execution of contingency plans, typically involving cost costingReaction to unplanned and unexpected events by organisational learning and exploitation of market signals
Response to external forces by reactive adaptation in proportion to impact on current businessShaping of controllable external forces by early, proactive engagement in proportion to impact on future business

Our work would suggest that it seems to be a case of the executives acting to reduce cognitive dissonance, which is a much reported phenomenon in managerial psychology. In simple terms, when executives are faced with new ways of thinking or doing things, they instinctively bias their view of the new approach to 'we do that already', because that makes them feel less challenged, more comfortable and allows them to avoid change. Hence, when they are introduced to the ideas of effectuation, executives rarely disagree with concept but instead assert strongly that they practice it. On closer examination, this is rarely the objective truth. In the table above, we reproduce some work from one company that resulted when we forced them to compare their current practice with the equivalent effectuation practice.

Clarified in this way, it was obvious to the executive team in this case that its current practice was very different from effectual practice and, in cases of high Knightian Uncertainty, a greatly inferior approach. But, to quote the senior person in the room: “We had to break a lot of old paradigms to get to that insight.” 

Horses for courses
High investment and leading-edge science mean that superior and appropriate risk management approaches are what separate high and low performing life science companies. And managing risk in life sciences markets is well described by the English idiom of 'horses for courses'; neither causal nor effectual approaches are 'best', but each is suited to different circumstances. Measurable risk situations are more common and so causal thinking is more usually the appropriate approach. But in cases of Knightian Uncertainty – typical in the long-term, high-stakes strategic choices on which the company's future depends - the effectual approach is necessary Thanks to Sarasvathy, we understand the core principles involved in implementing an effectual approach to strategy. But knowing or doing are two different things. In the end, managing uncertainty, rather than measurable risk, will demand a lot more broken paradigms.

Article by
Professor Brian D Smith

researches the evolution of competitive strategy in life sciences markets at the University of Hertfordshire and SDA Bocconi

25th July 2014

From: Research, Sales, Marketing



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