When CEOs launch an innovation or start a new business, the largest obstacle they face is uncertainty. Uncertainty stands in the foreground of today’s economy, geopolitical tensions and a digitally disrupted marketplace. Navigating this turbulent environment requires CEOs to use the appropriate decision-making tools for the novel situations they face.
Prediction, Risk and Uncertainty
Frank Knight, an early American economist, teased apart a distinction between risk and uncertainty. This distinction is helpful in the assessment of decision-making tools. When viewing the future as static and predictable, classic decision-making assumes future events are based on past recurring patterns. In this case, a decision-making approach uses analytical and predictive tools for choosing the best options available.
With a view of the future as dynamic and risky, however, decision-making requires an estimate of probable changes within multiple scenarios over time. This approach uses estimation techniques combined with existing information until a picture of the future begins to form and then behave more predictably, similar to a static future. At that point, predictive tools can be used again to choose the best options with probabilities for success.
But what about a future that is not only unpredictable, but unknowable? The view of this future is neither static nor dynamic, but blank. No historical data exists and the future cannot be modeled or predicted. This type of future is not only unknown, but unknowable. Navigating the future in the face of this kind of uncertainty requires a completely different approach.
Shaping the Future
Today’s CEOs face a future of uncertainty when launching ventures to create new products, new firms and new markets. It is important to learn how these CEOs work with uncertainty as an opportunity for innovation. One instructive avenue is based on entrepreneurship research conducted by Saras Sarasvathy, Darden School research professor at the University of Virginia.
Sarasvathy was interested in two primary questions: (1) What commonalities and differences exist in the decision-making process of a group of expert entrepreneurs and, (2) in the face of non-existent markets, what underlying beliefs about the predictability of the future influence their decisions as they build a new venture?
This led her to see entrepreneurial thinking as a domain of expertise and, as such, she found it had a logic of its own — one she called effectual. Effectual logic is distinctly different from causal logic. In the causal framework, CEOs create a detailed goal, gather market and competitive analysis and move forward with actions that will cause them to reach the goal, while managing the risk of deviating from that path. In the effectual framework, CEOs create a goal based on their resources and move forward iteratively to create and shape their venture, changing directions as new resources, opportunities and goals surface. Sarasvathy found that entrepreneurs build ventures, facing unknowable futures, by utilizing five key principles of this effectual logic.
Entrepreneurs start with their means or resources: who they are, what they know and whom they know. Who they are consists of traits, abilities, interests and other attributes of the entrepreneur. What they know consists of skills, education and experiences. Whom they know consists of their social network.
CEOs of mature companies can use this principle by assessing who they are as a company, identifying their capabilities and expertise and understanding their present and potential partners’ value.
Contrasted with the causal or predictable approach that starts with the future goal and collects the necessary resources to reach that goal, the effectual approach looks for effects that can be created from the present resources. The venture can then move forward using the next principle: affordable loss.
Entrepreneurs limit their risk by understanding what they can afford to lose in order to learn something about their product, market or capability. An affordable loss is one that will not result in business failure. It is an expense that leaves room for another action and another day in business.
CEOs launching a new venture within their mature business can prioritize actions according to their downside risk when facing uncertainty. This amounts to setting aside a budget to launch a new venture with milestone expenses assigned for iterative product development or market tests.
This is different than a causal approach which chooses options according to their predictable benefits and potential returns. Since the new venture must pivot until it finds traction in the marketplace, focusing on a specific return as opposed to affordable loss can cloud the visibility of novel product or service opportunities.
Entrepreneurs promote their ideas to others and build partnerships with self-selecting stakeholders as employees and external partners. The collaboration with new stakeholders brings new goals and resources to the venture.
CEOs can find partners within their organization as well as outside their organization. These self-selecting champions will bring new ideas and resources to bear on the new venture, potentially transforming it into something different from what it started out to be.
The venture does not necessarily dictate the partnerships; effectual partnerships actually help create and shape the venture. It becomes a collaborative project, more similar to making a movie than forming a picture from a picture puzzle.
When protected by affordable loss rather than managing for predicted risk, entrepreneurs invite surprise as a clue to altering new products, companies and markets. These unplanned events can provide upside opportunities.
CEOs can do this with new ventures by forming a framework and process to leverage contingencies rather than simply trying to adapt to or overcome them. In addition to exploiting positive contingencies, negative ones can be reframed to create assets.
The classical approach drives towards a specific goal, and must manage risk or variation from the plan. In contrast, the effectual approach considers the unexpected as a building block instead of seeing it as a problem. It is an example of the popular platitude, “when life gives you lemons, make lemonade.”
Entrepreneurs construct the future rather than predict the future. To the degree that the future can be controlled and constructed, the entrepreneur believes that it doesn’t need to be predicted.
Taking action on the present resources is more controllable than taking action on forecasted resources. Working with self-committed partners provides more control than market research on possible threats. Evaluating actions on downside risk controls the risks that are taken.
When CEOs launch new ventures, they should act quickly with the means at hand, assess the affordable loss, bring other people along and build on what they find. That is the way CEOs embrace uncertainty.
Multiple Tools for the Toolbox
It is important to remember that the effectual approach is not the only approach, nor is it necessarily better than the causal approach. The effectual approach is simply another tool for the CEO’s toolbox. Often, each tool is required at different points during the life cycle of a venture.
The appropriate decision-making tool is dependent upon the type of future encountered: predictable or uncertain. A predictable future requires a CEO to choose between probable outcomes. An unknowable future requires a CEO to construct and shape that future.
In these turbulent times, the effectual tool is especially effective when navigating uncertainty in the launch of a new venture.
Don Springer is co-founder of The Colton Group, a board directorship and executive advisory firm based in Dallas providing actionable growth strategies for emerging businesses, global companies, and social enterprises. He has Fortune 200 experience as President of a Ford Motor Co. technology subsidiary, CEO of a Microsoft VAR, EVP of an EDS venture, and an early career at Texas Instruments. http://www.coltongroup.com
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