Thinking out of the box

Published 29 July 2010 06:33, Updated 09 September 2010 04:15

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Entrepreneurs must do one of three things to have any hope of succeeding, according to state government business help desk, Business Victoria.

They must either fill a gap in the current market, enter a market where demand is greater than supply, or offer a “really big difference”, such as a better price or location.

Most would-be business owners are confronted by this basic checklist at every government business website they visit, every business school they enrol in and every accountant they consult. Unfortunately, it is often wrong.

At least, this is the conclusion drawn by University of Virginia Darden Business School associate professor Saras Sarasvathy after studying the characteristics, habits and behaviours of 30 founders of United States companies valued from $US200 million ($230 million) TO $US6.5 billion and selling everything from steel to teddy bears.

What this group has in common is not superior business plans, reports Sarasvathy, but a way of thinking that deviates from the standard advice offered to entrepreneurs.

“We teach potential entrepreneurs an extremely causal process – the sequential progression from idea to market research, to financial projections, to team, to business plan, to financing, to prototype, to market, to exit – with the caveat of course, that surprises will happen along the way,” she says.

“Seasoned entrepreneurs, however, know that surprises are not deviations. Instead they are the norm ... and transforming the unpredictable into the utterly mundane is the special domain of the expert entrepreneur.”

Sarasvathy illustrates the difference with the example of starting an Indian restaurant. Following standard advice, an aspiring restaurateur would start with some market research into the industry, select an under-served location, target customers based on estimates of return, design a restaurant to appeal to them and raise the required funding.

Basing the restaurant on market research that may or may not predict the future, far from assuring success, Sarasvathy says, simply raises the cost of failure.

By contrast, a seasoned entrepreneur would try to reduce both the cost and likelihood of failure by taking a more experimental approach. For instance, they might try to persuade friends who work downtown to allow her to bring lunch for their office colleagues to try.

“Some customers then sign up for a lunch service and she begins preparing the food at home and delivering lunches personally. Eventually, she could save up enough money to rent a location and start a restaurant. But it could be equally plausible that the lunch business model does not take off beyond the first few customer; instead our entrepreneur discovers the customers are interested in her ethnic philosophy or Indian culture or other aspects of her personality, expertise, contacts or interests. She could then decide to go into any one of several different businesses contingent upon the ensuing feedback.”

Economist John Kay labels this experimental approach “obliquity”, which is also the title of his new book. Kay, a visiting professor at the London School of Economics and a fellow of St John’s College, Oxford, says starting a business, like other real-world problems, is not “solved” by a business plan, however comprehensive. The world is too complex to represent on a page or in a spreadsheet, he says.

“We suffer not just from ignorance of the future, but from a limited capacity to imagine what the future might be,” Kay writes. “Such a failure of imagination is inevitable. If you could have anticipated the functions and uses of the personal computer, you would already have taken the main steps towards inventing it.

“Most of what will be important in the future is outside our knowledge; it exists only in the future. The direct approach demands a capacity for prediction that we can never possess,” he insists.

Entrepreneurs accept they cannot predict or even imagine the future, but instead of resigning themselves to it, Sarasvathy says, they see it is as an opportunity to help create the future.

“Entrepreneurs are entrepreneurial, as differentiated from managerial or strategic, because they think effectually; they believe in a yet-to-be-made future that can substantially be shaped by human action; and they realise that to the extent that this human action can control the future, they need not expend energies trying to predict it,” she says.

The good news is that anyone can learn to be entrepreneurial. Sarasvathy identifies three “eminently teachable principles”. The first is the affordable loss principle. While managers ask “how much time, effort and money do I need to achieve the highest potential return?”, entrepreneurs ask “what can I do with the resources I already have?”

“In finding the first customer within their immediate vicinity ... entrepreneurs do not tie themselves to any theorised or preconceived market or strategic universe for their idea,” Sarasvathy says.

“Instead, they open themselves to surprises as to which market or markets they will eventually end up building their business in, or even which new markets they will end up creating.”

A second important principle of entrepreneurialism is leveraging contingencies. “Great entrepreneurial firms are products of contingencies,” Sarasvathy says. “The realisation that not all surprises are bad and that surprise, whether good or bad, can be used as inputs into the new-venture creation process differentiates effectual reasoning from causal reasoning, which tends to focus on the avoidance of surprises to the fullest extent possible.”

For instance, entrepreneurs in Sarasvathy’s study starting with exactly the same product ended up creating companies in 18 separate industries.

A third principle is forming strategic partnerships. As in the hypothetical restaurant example above, entrepreneurs enlist real customers, even if they are friends and family, to provide feedback on initial concepts and possible markets. Managers, by contrast, surround themselves with market research reports that don’t answer back, but may not reflect how actual people will respond.

“The strategic partnerships principle reduces uncertainty in the early stages of creating an enterprise and brings the concept to market at really low levels of capital outlay,” Sarasvathy says.

She stresses that managerial thinking still has its place, especially as a business matures. “In fact, the best entrepreneurs are capable of both [ways of thinking] and do use both models well. But they prefer effectual reasoning over causal reasoning in the early stages of a new venture.”

In other words, it is not so much that the advice of Business Victoria and others is wrong, but that it is being given to the wrong people. Planning, it seems, is not the substitute for experience that bureaucrats would like it to be.

Two sides of the coin

ManagerEntrepreneur
Causal Effectual
Expected return Affordable loss
“What is my goal?” “What can I do?”
Competitive analysis Strategic partnerships
Exploitation of pre-existing knowledge and prediction Leveraging of contingencies

Decisions are made on the basis of the fullest possible information Decisions are made after recognising that only limited knowledge of the world is, or can be, available
The rational decision maker is consistent Consistency is a minor, and possibly dangerous, virtue
“To the extent that we can predict the future, we can control it” “To the extent that we can control the future, we do not need to predict it”

Source: Saras Sarasvathy; John Kay

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