I recently ran into an article (Walrave et al 2011) that analyzed a simulation of investing in exploration vs. exploitation. The decision to invest in (mainly short-term oriented) exploitation or to invest in (mainly long-term oriented) exploration is one of the key concepts of management and often referred to as ambidexterity.
Model of Exploration vs. Exploitation
The article built a simulation and was able to test the effective of different strategies under different circumstances. The main elements of the model were:
- Exploitation loop: a reinforcing loop that suggests that when companies invest in exploitation, they will see an increase in exploitative profits, which will thus increase the likelihood of sticking to that strategy.
- Explorative loop: a reinforcing loop that suggests that when companies invest in exploration, the will see an increase in explorative profits, which will thus increase the likelihood of sticking to that strategy.
- External pressure: a balancing loop that suggests that both the exploitative loop and explorative loop will be disturbed by the market circumstances (a realism check), which will thus increase the likelihood of external forces saying that the strategy should change. I know this sounds a bit complex, but imagine a company that always tempts to stick the exploitative loop. Without intervention this will work till the end of time. However, because of the success of this strategy, there will be a decrease of competition (from your perspective) resulting in external pressure to focus more on exploration.
Download the full infographic for an overview of the model:
When you take a closer look at this model, it “proves” a few interesting things:
- Startups will not be able to hold fast to a (extremely) explorative strategy forever. External pressure will force them to change their strategy to exploitation.
- Publicly owned companies will have trouble breaking out from the exploitation loop, because external pressure (stakeholders) is mainly financially – and short-term – driven and will therefore overestimate the importance of an exploitation strategy.
- Family owned companies are more likely to move towards the explorative loop, because they tend to give more weight to long-term profits than short-term profits.
- A monopolistic position in a certain market will reduce the external pressure to invest in exploitation.
- A highly competitive market will reduce the external pressure to invest in exploration and increase the external pressure to invest in exploitation.
- A volatile market or ecosystem will reduce the external pressure to invest in exploitation or increase the external pressure to invest in exploration.
- A calm market or ecosystem will increase the external pressure to invest in exploitation.
Adaptive Strategy Matrix
Based on the four external conditions there are four different exploration-exploitation strategies that we suggest:
- Passionate strategy: an ad hoc, ‘free’ strategy in a market without serious competition but with volatile, energetic circumstances. Theory suggests that companies in these circumstances should invest between 60% and 80% of their total spendings on exploration and just 20%-40% on exploitation. In this strategy companies focus on social innovation, entrepreneurship, ideation and technology.
- Flamboyant strategy: a competitive strategy in a highly energetic ecosystem with lots of opportunities. Companies should invest between 50%-70% on exploration and the rest in exploitation. Strategic focus lies on marketing, co-creation and business model innovation and open innovation.
- Relaxed strategy: usually in a niche market, without serious competition and with calm and stable circumstances. No need to invest a lot of resources in exploration, but no need to invest in exploitation as well. Usually this leads to an optimal ratio of 30% in exploration and 70% in exploitation. Focus on social innovation and ideation.
- Nervous strategy: an innovation strategy that is necessary to follow in a highly competitive market that lack opportunities or future. There is a strong need for exploitative investments (up to 100%) to stay ahead of competition. A very nervous, and short-term focused market. Focus on Business Model Innovation, Open Innovation, Marketing and Branding.