Early this year, the Wall Street Journal and the Heritage Foundation announced the results of their annual survey of economic freedom. Using criteria such as market access and the protection of property rights, the survey ranked countries by the level of economic freedom they permit. Hong Kong and Singapore top the list, Switzerland and the United States are fifth, and most European countries are in the upper middle of the range.

The survey noted that the political leaders of many countries—such as those in Latin America—have chosen to move in the direction of economic freedom. Moreover, there appears to be a strong correlation between economic freedom and growth. Countries blessed with natural resources or technological progress but with little economic freedom have not prospered, and aid to nations that lack economic freedom has had little effect on growth.

Strategic freedom

As I read the survey, I wondered if I could make a similar argument for strategic freedom in the world of business. What criteria would I use to assess it? Is the private sector choosing to become more strategically free, or do we run our companies like repressed countries? Is there a correlation in the corporate world between strategic freedom and growth? Is capital invested in strategically constrained businesses unlikely to generate wealth?

Now, McKinsey has not developed a ranking of companies based on their strategic freedom, but in a sense the market has. Let me explain. Our research indicates that a company’s value is the product of market expectations of four variables:

• The net present value of cashflows from legacy assets
• The value of the growth opportunities the company has in hand
• The value of its ability to generate new options
• The option value of its flexibility to change its financial and ownership structure.

The last three variables provide companies with the biggest opportunity to change market expectations and increase shareholder value. After analyzing the success of one well-regarded multinational, for example, we concluded that the enormous rise in its shareholder value over the past decade has been due much less to legacy assets than to the creation of option value. Kevin Kelly of Wired magazine puts it this way: "Wealth in this new regime flows directly from innovation, not optimization. That is, wealth is not gained by perfecting the known, but by seizing the unknown."¹

So the market clearly values strategic freedom. Are our four dimensions of freedom broader and more available to companies than they were a decade ago? The answer must be yes. The growing scope to exploit tangible and intangible assets worldwide has been well documented, as have underlying forces such as the decline in transportation and communication costs. The continuing fall of regulatory barriers, the expansion of liquid and global capital markets, the abundance of alliance partners, the emergence of new structures of ownership—all these developments would have given managers the opportunity to raise their ranking on an index of strategic freedom, if such a thing existed.

But freedom of whatever kind usually comes at a price. For politicians, economic freedom is not easy to embrace. Opening borders to foreign competitors brings accusations of lost jobs. For many business leaders, too, strategic freedom is a threat—one that multiplies the number of decisions they need to make. A would-be globalizer, for example, can no longer plan to expand gradually into a few more countries every year; instead, it must discover ways to reshape the structure of industries, control critical assets, and attract partners, worldwide.

In fact, any analysis of strategic freedom uncovers the same forces that are driving globalization. Next year, four of my colleagues will publish a book that argues that globalization is about to enter a second stage in which 80 percent of the world’s GDP will be available to companies from any country.² That sounds great, but even the most seasoned managers of multinationals are having difficulty coping with such an enormous opportunity.

Meanwhile, a few of their competitors, by not only growing earnings but also increasing their return on book equity, have attained incredibly high market capitalizations that allow them to acquire others that have not performed so well. My colleagues contend that this challenge—the market capital imperative—is one you all must meet. Put another way, as globalization gathers pace, the cost of freedom, the cost to stay free, will soar.

So you must act now to preserve your freedom, indeed your very existence. Yet the forces driving strategic freedom are rapidly raising levels of uncertainty. Consider just one development: lower transaction costs. Our research suggests that at national, industry, and firm levels, interactions today can account for upward of 50 percent of labor costs.³ As the cost of these interactions plummets, the way industries are structured, firms are organized, and customers behave will be transformed.

The possibilities presented by vanishing transaction costs are fabulous. But the uncertainty is enormous. How, for example, will firms trade off the value of specialization against the interaction costs associated with external suppliers? How will they trade off the effectiveness of alternative nonhierarchical organizations against the increase in interaction costs involved in managing them? And how will customers choosing products and providers trade off the decreasing interaction costs of further search against the marginal value expected from it?

Not surprisingly, many companies are allowing mounting uncertainty to freeze them into indecision. But strategy is still about tough choices. Particularly in uncertain conditions, winners will need to make industry- and standard-shaping decisions to create the future rather than just let it happen to them.

Managers clearly need to improve their ability to understand and differentiate between levels of uncertainty. When are you facing a future comprising a few discrete outcomes? When are you facing a range of possible outcomes, but no obvious scenarios? And when are you facing true ambiguity, with no basis from which to forecast the future?

We have found that analytical frameworks that are useful at one level of uncertainty are useless at another. Under true ambiguity, scenario planning is like whistling in the dark. So are such traditional metrics as discounted cashflow. We have also concluded that the level of uncertainty will greatly affect your strategic posture: by that, I mean whether you try to shape the future, adapt to it, or simply reserve the right to play. That doesn’t, however, mean that high uncertainty calls for hedging strategies.

"Strategy" thus ends up being a portfolio of three different kinds of decision: big bets with high upside and downside; options that keep you in the game; and no-regrets moves that you believe will pay off no matter what the future brings. Together, these decisions drive changes in market expectations and value. As a result, some of my colleagues believe the corporation should be redefined as the creator, developer, and trader of options.

Organizational freedom

Now, as transparent and yet uncertain as the world is becoming, the market’s evaluation of your options and your ability to exploit strategic freedom falls back on its assessment of the people you have assembled, the consistency of your decision processes, and your track record. In other words, it bets on people and organization.

For a long time, all of us have paid lip service to organization. No more. The organization of the future must be radically new, filled corner to corner with true entrepreneurs and leaders. You cannot create a stream of opportunities from the center. If the index of strategic freedom is destined to soar to new heights, then so must organizational freedom. Indeed, I would offer this corollary: our major challenge, now and in the decades ahead, will be to ensure that the freedom within our organizations equals the freedom without.

In the late 1970s, GE and McKinsey developed the concept of natural business units. To some extent, it was a small step toward putting a complete business around a group of managers and letting them own it. But it wasn’t true ownership. When portfolio theory appeared, we belatedly added that different types of manager should be assigned to different boxes in the matrix. At about the same time, we developed the "7S" theory of organization. It argued that variables such as structure, skills, systems, and strategy all had to be in sync.

In the years since then, we have pushed forward our thinking about decentralization, incentives, and spinoffs. But we must push further. It’s going to be much more complex in future. The variables will include:

• Asset ownership
• Decision authority
• Performance metrics
• The role of the corporate center
• And the process by which capital is allocated.

And instead of pouring over the minutiae of compensation schemes, we are going to have to figure out how to get the fit between these variables right. Otherwise, we will not be able to keep good people.

To do that, we will need to break the tradeoff between entrepreneurialism and control. Until recently, academic thinking held that organizations had to choose between entrepreneurialism and coordination. Markets do a good job of encouraging the first, hierarchy, the second. So we give up one to get the other. But maybe that tradeoff is disappearing. Maybe we can design organizations that have both. Maybe that’s the essence of what the Silicon Valley companies have done. And maybe it’s time for senior managers to be much bolder about it.

It is possible. All the forces that are promoting strategic freedom can also be used to increase organizational freedom without sacrificing coordination. The boundary between the external market and the internal organization is disappearing as more and more so-called "relational forms"—forms of organization that sit on the continuum between market-determined and hierarchy-determined—are developed.⁴ The old dichotomy of controlling some assets and activities and transacting for others in the market has been enriched by a variety of options that provide more initiatives for employees and induce or enforce cooperation with external entities.

Indeed, the task should no longer be called organization, but configuration—configuration for influence. The ways in which configuring for influence can boost performance are more powerful and diverse than we may realize. There are genuinely new ways to participate in opportunities that yield increasing returns, attract and motivate top talent, and, most important, let the power of market forces into our companies.

The hard part for most companies is to get started; frankly, the only way to do it is for top management to exercise leadership and make tough decisions about resource allocation. Identifying potential opportunities means little unless these are funded to convert intangible assets into the intangible capital required for success—that is, by investing in brands, technology, local market knowledge, and so on. It will also be necessary to involve some of the most talented up-and-coming leaders in the firm. And fledgling initiatives will need protecting from a line organization that wants to use their funding, talent, and other assets to pursue more traditional opportunities.

My colleagues working on globalization call for the use of "talent teams" with considerable expense budgets and the authority to create new businesses—as long as they do it with other people’s capital. If they succeed, they not only earn the right to run the business, but own a piece of it.

The design and configuration of our organizations, industries, and networks have to take into account the different varieties of capitalism and the different regulatory regimes in which we operate. But the variables are the same. All of us have been caught for many years between markets and hierarchies. Somehow we must find ways to resolve and release that tension.

Trust

One last thought: trust will be the key determinant of success for new strategies. Again, the parallel between countries and corporations is striking. Writing in the Wall Street Journal, the columnist George Melloan put it this way, "One of the pejoratives we have heard quite a bit this year is ’crony capitalism,’ referring to nominally capitalistic, free-market states in which national leaders have used the powers granted to them by all the people to enrich a favored few.... There is a legitimate sense among the people that their governments have broken faith."⁵

Just as for countries, strategy for companies is going to be about trust: earning it and keeping it. Let me be specific. Our research into privileged relationships—the sort that mean you get the business instead of the guy down the road—indicates that they depend on three factors: competence, motives, and reliability. The task of configuration is ultimately about forming privileged relationships with both insiders and outsiders.

The financial markets have converted what were once attractive options to grow into obligations to grow

Employees in your organization are going to have to trust the commitment of your corporate center to a level of decision rights and rewards for success. Consumers will need to trust you enough to stop looking for alternatives. The financial markets will need to trust your people’s ability to generate or acquire options and turn them into profitable businesses. These markets understand that players with strong brands, intellectual property, or other knowhow are well positioned to take advantage of new opportunities, and this is now built into their expectations. They have converted what were once attractive options to grow into obligations to grow. You can’t afford to disappoint them.

Web and alliance partners from different countries and cultures will need to trust your commitment to developing and maintaining a business model and its underlying technology or market standard. As McKinsey partner John Hagel pointed out in his book Net Gain,⁶ networks—groups of companies whose business interests are interconnected in some way—are like countries. Those that act first to ensure the prosperity of the network prosper themselves. The law of increasing returns takes over, and the tide rises for all in the network. This is something many national leaders have failed to recognize, and something myopic strategists will also miss.

Earning trust will depend on using a language common to both insiders and outsiders. Strategy over the past decade has become a mishmash of theories and frameworks. Perhaps we all need a new language of strategy. If a corporation should indeed be thought of as the creator and developer of options, this new language will explicitly link expectations with time. Are you making investments to capture near-term opportunities, create new businesses over the next three to five years, or explore longer-term and less certain options? Our accounting systems do a lousy job of differentiating between expenses for running current businesses and expenses for growing intangible assets. You will need to make that distinction clear.

You will also need to work out how you will decide to continue with or abandon further investments. What metrics will you use? How will you value options? The new language will need to be clear about the risks your organization wishes to take and is better able to take than others. In developing this language, you will need to wrestle with your assumptions about finance, strategy, investor expectations, and organization, and especially with the boundaries of your organization and how you decide where to draw them.

Strategy has always had an element of secrecy about it, and that will no doubt continue. But it is time to make the process by which you generate and develop strategies open to constituents and potential partners. Manufacturers have learned to share technologies with favored suppliers. This is only the first step toward the day when all of us regularly give away pieces of our intellectual capital in order to attract employees and partners who will generate greater wealth.

I’ve tried to make three points here. First, enormous strategic freedom is available to all of us. Some of us have found the task of responding to it extremely challenging. Others believe they have seized the opportunity. But many companies are still focused on their legacy assets and the growth options they already have in hand. If they are unwilling to shed some of these assets, they may see them turn into chains that cost them their freedom. And if they take a hard look at how their market capitalization compares with their book equity, they can assess whether the investment community judges them to be strategically free.

Second, whether you have the ability to exploit all four dimensions of strategic freedom depends on your organization. Those who have experimented with internal venture groups and privileged supplier relationships may think they are state of the art. But they may not even be close. There are many other options open to you to configure both what you own and what you influence so that you take only the risks you should take and leave the rest to others better able to take them, whether employees or outsiders. We must all learn to use market forces—both consumer and investor market forces—to validate our strategies and inspire our people.

Third, trust will be key. Not vague or personal loyalty to your past performance, but highly specific expectations about your future behavior, your ability and willingness to keep your commitments, and the processes you use to make decisions. Only with trust can you attract the people and partners that will keep you free.